On the Perils of Stabilizing Prices When Agents are Learning

50 Pages Posted: 4 Feb 2015

See all articles by Antonio Mele

Antonio Mele

University of Surrey

Krisztina Molnar

Norwegian School of Economics (NHH) - Department of Economics

Sergio Santoro

Bank of Italy

Multiple version iconThere are 3 versions of this paper

Date Written: January 30, 2015

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 confidence, 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: optimal monetary policy, learning, price level targeting

JEL Classification: C620, D830, D840, E520

Suggested Citation

Mele, Antonio and Molnar, Krisztina and Santoro, Sergio, On the Perils of Stabilizing Prices When Agents are Learning (January 30, 2015). CESifo Working Paper Series No. 5173. Available at SSRN: https://ssrn.com/abstract=2559736

Antonio Mele

University of Surrey ( email )

Guildford
Guildford, Surrey GU2 5XH
United Kingdom

Krisztina Molnar (Contact Author)

Norwegian School of Economics (NHH) - Department of Economics ( email )

Helleveien 30
N-5035 Bergen
Norway

Sergio Santoro

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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