Optimal monetary policy with uncertain private sector foresight

Christopher Gust, Edward Herbst and David López-Salido

Journal of Monetary Economics, 2025, vol. 155, issue C

Abstract: We model private-sector expectations in a finite-horizon-planning framework: households and firms have limited foresight when making spending, saving, and pricing decisions. In this setting, contrary to standard New Keynesian (NK) models, we show that an “inflation scare” problem can arise in which agents’ longer-run inflation expectations deviate persistently from a central bank’s inflation target. We characterize optimal time-consistent monetary policy when there is uncertainty about the planning horizons of private sector agents and a risk of inflation scares. We show how risk-management considerations modify the optimal “leaning-against-the-wind” principle in the NK literature with a novel, additional preemptive motive to avert inflation scares.

Keywords: Finite-horizon planning; Optimal monetary policy under uncertainty (search for similar items in EconPapers)
JEL-codes: C11 E52 E70 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:155:y:2025:i:c:s0304393225000972

DOI: 10.1016/j.jmoneco.2025.103826

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