Optimal Monetary Policy When Agents are Learning
By Krisztina Molnár, Sergio Santoro. Social Science Research Network, 2010
126 citations recorded by the source corpus.
Most studies of optimal monetary policy under learning rely on optimality conditions derived for the case when agents have rational expectations. In this paper, we derive optimal monetary policy in an economy where the Central Bank knows, and makes active use of, the learning algorithm agents follow in forming their expectations. In this setup, monetary policy can influence future expectations through its effect on learning dynamics, introducing an additional tradeoff between inflation and output gap stabilization. Specifically, the optimal interest rate rule reacts more aggressively to out-of-equilibrium inflation expectations and noisy cost-push shocks than would be optimal under rational expectations: the Central Bank exploits its ability to †drive†future expectations closer to equilibrium. This optimal policy closely resembles optimal policy when the Central Bank can commit and agents have rational expectations. Monetary policy should be more aggressive in containing inflationary expectations when private agents pay more attention to recent data. In particular, when beliefs are updated according to recursive least squares, the optimal policy is time-varying: after a structural break the Central Bank should be more aggressive and relax the degree of aggressiveness in subsequent periods.
Subfields: Economics and Econometrics
View Paper: https://www.semanticscholar.org/paper/0ca2e5e2e4d2995954f3b49ba1c6ee92930a2461
Citations in the corpus
- The science of monetary policy: an imperfect knowledge perspective (2018, unknown): “: (41) This target criterion, rst derived by Molnar and Santoro (2013) under the Euler Equation approach, states in ation should be proportional to the output gap, adjusted for the expected discounted value of the sequence of output gaps into the in nite future.”
- Robustly Optimal Monetary Policy with Near Rational Expectations (2010, unknown): “Other parameter values are as in Figure 1; in addition, it is assumed here that σu = 0.02. which is zero when (3.12) holds, but negative when θ is finite.”
- National culture and bank risk-taking (2017, unknown): “Third, banks are the major vehicle through which a country’s Central Bank applies its monetary policy, that is, inflation stability, regulatory application, and expectations management, for the benefit of society (Molnár and Santoro, 2014).”