Scandinavian Working Papers in Economics

Discussion Paper Series in Economics,
Norwegian School of Economics, Department of Economics

No 1/2015: On the perils of stabilizing prices when agents are learning.

Antonio Mele (), Krisztina Molnar () and Sergio Santoro ()
Additional contact information
Antonio Mele: University of Surrey, Postal: Guildford, , Surrey, GU2 7XH, , United Kingdom,
Krisztina Molnar: Dept. of Economics, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Economics, Helleveien 30, N-5045 Bergen, Norway
Sergio Santoro: Bank of Italy, Postal: Via Nazionale 91, 00184 Rome, Italy,

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 su ffer the corresponding welfare losses. However, these losses are outweighed by short term gains from the learning phase.

Keywords: Price level stabilization; expectations.

JEL-codes: C62; D83; D84; E52

49 pages, December 19, 2014

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