Inflation expectations and the transmission of monetary policy
No 1998-43, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)
New Keynesian models with sticky prices and rational expectations have a difficult time explaining why reducing inflation usually requires a recession. An explanation for the costliness of reducing inflation is that inflation expectations are less than perfectly rational. To explore this possibility, I estimate the degree of nonrationality implicit in two survey measures of inflation expectations. I find that the surveys reflect an intermediate degree of rationality: Expectations are nether perfectly rational nor as unsophisticated as simple autoregressive models would suggest. I also find that a structural New Keynesian model with expectations formation based on the survey results is able to match closely the empirical costs of reducing inflation.
Keywords: Inflation (Finance); Monetary policy (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:1998-43
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