Research Discussion Papers, Bank of Finland
No 20/2003:
Learning, inflation expectations and optimal monetary policy
Eric Schaling
Abstract: In this paper we analyse disinflation policy in two
environments. In the first, the central bank has perfect knowledge, in the
sense that it understands and observes the process by which private sector
inflation expectations are generated; in the second, the central bank has
to learn the private sector inflation forecasting rule. With imperfect
knowledge, results depend on the learning scheme that is employed. Here,
the learning scheme we investigate is that of least-squares learning
(recursive OLS) using the Kalman filter. A novel feature of a
learning-based policy – as against the central bank’s disinflation policy
under perfect knowledge – is that the degree of monetary accommodation (the
extent to which the central bank accommodates private sector inflation
expectations) is no longer constant across the disinflation, but becomes
state-dependent. This means that the central bank’s behaviour changes
during the disinflation as it collects more information.
Keywords: learning; rational expectations; separation principle; Kalman filter; time-varying parameters; optimal control; (follow links to similar papers)
JEL-Codes: C53; E43; E52; F33; (follow links to similar papers)
53 pages, August 18, 2003
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