Boundedly Rational Expectations and the Optimality of Flexible Average Inflation Targeting

Anthony Brassil, Christopher Gibbs and Callum Ryan
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Anthony Brassil: Reserve Bank of Australia
Christopher Gibbs: University of Sydney
Callum Ryan: Reserve Bank of Australia

RBA Research Discussion Papers from Reserve Bank of Australia

Abstract: Expectations play a central role in the transmission of monetary policy, but how people form expectations is widely debated. We revisit optimal monetary policy design in a model with behavioural expectations that nest rational and adaptive learning beliefs as special cases, and approximates several alternative expectations theories, such as myopic or level- k expectations. Optimal policy is a weighted average inflation target plus adjustments for belief persistence and constraints faced by the central bank (information frictions and the zero lower bound). Optimal policy is well-approximated in all cases by flexible average inflation targeting, where we make explicit what average and flexible mean.

Keywords: optimal policy; behavioural macroeconomics; average inflation targeting; zero lower bound (search for similar items in EconPapers)
JEL-codes: D83 D84 E31 E32 E52 E71 (search for similar items in EconPapers)
Date: 2025-04
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Persistent link: https://EconPapers.repec.org/RePEc:rba:rbardp:rdp2025-02

DOI: 10.47688/rdp2025-02

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