Research Discussion Papers, Bank of Finland
No 32/2007:
Expectations, learning and monetary policy: an overview of recent research
George W Evans and Seppo Honkapohja ()
Abstract: Expectations about the future are central for
determination of current macroeconomic outcomes and the formulation of
monetary policy. Recent literature has explored ways for supplementing the
benchmark of rational expectations with explicit models of expectations
formation that rely on econometric learning. Some apparently natural policy
rules turn out to imply expectational instability of private agents’
learning. We use the standard New Keynesian model to illustrate this
problem and survey the key results for interest-rate rules that deliver
both uniqueness and stability of equilibrium under econometric learning. We
then consider some practical concerns such as measurement errors in private
expectations, observability of variables and learning of structural
parameters required for policy. We also discuss some recent applications,
including policy design under perpetual learning, estimated models with
learning, recurrent hyperinflation, and macroeconomic policy to combat
liquidity traps and deflation.
Keywords: imperfect knowledge; learning; interest-rate setting; fluctuations; stability; determinacy; (follow links to similar papers)
JEL-Codes: D84; E31; E52; (follow links to similar papers)
49 pages, December 14, 2007
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