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Inflation Targeting, Recursive Inattentiveness, and Heterogeneous Beliefs

Anna Agliari (), Domenico Massaro, Nicolò Pecora and Alessandro Spelta

Journal of Money, Credit and Banking, 2017, vol. 49, issue 7, 1587-1619

Abstract: We consider a monetary authority that provides an explicit inflation target in order to align expectations with the policy objective. However, biased perceptions of the target may arise due to imperfect information flows. We allow agents to revise expectations over time and we model their recursive choice among prediction strategies as an optimization problem under rational inattention. We then investigate whether a simple policy rule can steer the economy toward the targeted equilibrium. Our findings suggest that determinacy under rational expectations may not be sufficient to reach the target. Instead, monetary policy should be fine‐tuned to correct agents' biased beliefs.

Date: 2017
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Working Paper: Inflation Targeting, Recursive Inattentiveness and Heterogeneous Beliefs (2014) Downloads
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