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Some implications of learning for price stability

Stefano Eusepi, Marc Giannoni () and Bruce Preston ()

European Economic Review, 2018, vol. 106, issue C, 1-20

Abstract: Survey data on expectations of a range of macroeconomic variables exhibit low-frequency drift. In a New Keynesian model consistent with these empirical properties, optimal policy in general delivers a positive inflation rate in the long run. Two special cases deliver classic outcomes under rational expectations: as the degree of low-frequency variation in beliefs goes to zero, the long-run inflation rate coincides with the inflation bias under optimal discretion; for non-zero low-frequency drift in beliefs, as households become highly patient valuing utility in any period equally, the optimal long-run inflation rate coincides with optimal commitment – price stability is optimal. The optimal state-contingent response to cost-push disturbances similarly reflects properties of optimal discretion and optimal commitment, depending on the degree of low-frequency variation in beliefs. When beliefs exhibit substantial variation in response to short-run forecast errors, optimal policy is closer to commitment.

Keywords: Optimal monetary policy; Learning dynamics; Price stability (search for similar items in EconPapers)
JEL-codes: E32 D83 D84 (search for similar items in EconPapers)
Date: 2018
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