Discussion Paper Series in Economics, Department of Economics, Norwegian School of Economics (NHH)
On the perils of stabilizing prices when agents are learning.
(), Krisztina Molnar
() and Sergio Santoro
Abstract: We show that price level stabilization is not optimal in
an economy where agents have incomplete knowledge about the policy
implemented and try to learn it. A systematically more accommodative policy
than what agents expect generates short term gains without triggering an
abrupt loss of confi dence, since agents update expectations sluggishly. In
the long run agents learn the policy implemented, and the economy converges
to a rational expectations equilibrium in which policy does not stabilize
prices, economic volatility is high, and agents suffer the corresponding
welfare losses. However, these losses are outweighed by short term gains
from the learning phase.
Keywords: Price level stabilization; expectations.; (follow links to similar papers)
JEL-Codes: C62; D83; D84; E52; (follow links to similar papers)
49 pages, December 19, 2014
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