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Inflation Expectations and Monetary Policy

Jan Filáèek ()
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Jan Filáèek: Czech National Bank

Authors registered in the RePEc Author Service: Jan Filáček

Czech Journal of Economics and Finance (Finance a uver), 2005, vol. 55, issue 7-8, 380-394

Abstract: This paper shows that an economy’s behavior differs significantly according to assumptions made on the formation of inflation expectations. We analyzed the behavior of an open economy in a regime of explicit inflation targeting with commitment. The economy is exposed to three different shocks – demand, supply, and exchange rate – and its reaction is analyzed under three different assumptions on inflation-expectations formation: naive, rational, and adaptive learning. The economy in which rational expectations were assumed showed the least volatile development and minimized the central bank’s loss function. The stabilizing effect of this forward-looking type of expectation was most evident in the case of supply shock. When naive expectations were assumed, the economy reacted to all shocks with significantly bigger and longer-lasting fluctuations. The worst results were obtained assuming adaptive-learning expectations, where shocks lead to large oscillations and the economy stabilized only several years after the shock.

Keywords: inflation expectation; model simulation; monetary policy (search for similar items in EconPapers)
JEL-codes: E31 E37 E52 (search for similar items in EconPapers)
Date: 2005
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