Posted

August 01, 2010 12:00:00 AM

Date

2010-05-27

Author

Krisztina Molnár and Sergio Santoro

Affiliation

Norges Bank and Bank of Italy

Title

Optimal Monetary Policy When Agents Are Learning

Summary /
Abstract

We derive the optimal monetary policy in a sticky price model when private agents follow adaptive learning. We show that this slight departure from rationality has important implications for policy design. The central bank faces a new intertemporal trade-off, not present under rational expectations: it is optimal to forego stabilizing the economy in the present in order to facilitate private sector learning and thus ease the future intratemporal inflation-output gap trade-offs. The policy recommendation is robust: the welfare loss entailed by the optimal policy under learning if the private sector actually has rational expectations is much smaller than if the central bank mistakenly assumes rational expectations when in fact agents are learning.

URL:http://d.repec.org/n?u=RePEc:bno:worpap:2010_08&r=mac

Keywords

optimal monetary policy, learning, rational expectations

URL

http://www.norges-bank.no/templates/article____76978.aspx

Remarks

This interesting paper concludes that, if the central bank does not know the exact nature of private inflation expectations (whether rational or adaptive), monetary policy focused on lowering and stabilizing inflation, as opposed to stabilizing employment/economic activity, is the optimal monetary policy.

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