Monetary Policy with Diverse Private Expectations

47 Pages Posted: 9 Apr 2015

See all articles by Mordecai Kurz

Mordecai Kurz

Stanford University - Department of Economics

Maurizio Motolese

Catholic University of Milan

Giulia Piccillo

Maastricht University; Liverpool University; Utrecht University - School of Economics

Howei Wu

Shanghai University of Finance and Economics

Date Written: March 30, 2015


We study the impact of diverse beliefs on conduct of monetary policy. We use a New Keynesian Model solved with a quadratic approximation. Aggregation renders the belief distribution an aggregate state variable. Diverse expectations change standard results about a smooth trade-off between inflation and output volatility. Our results are: (i) The policy space contains a curve of singularity which is a collection of policy parameters that divides the space into two sub-regions. Trade-off between output and inflation volatilities exists within each region and some across regions. (ii) The singularity causes volatility of variables to be non monotone in policy parameters. (iii) When beliefs are diverse a central bank must also consider the volatility of individual consumption and the related volatility of financial markets. We show aggressive anti-inflation policy increases consumption volatility and aggressive output stabilization policy entails rising inflation volatility. Efficient central bank policy must therefore be moderate. (iv) Optimism about the future typically lowers aggregate output and increases inflation. This "stagflation" effect is stronger the stickier prices are. Policy response is muted since the effects of higher inflation and lower output on interest rates partially cancel each other. Effective policy requires targeting exuberance directly or its effects in asset markets. Central banks already do so with short term interventions. (v) The observed high serial correlation in policy shocks contributes greatly to market volatility and we show that a reduction in persistence of central bank's deviations from a fixed rule will contribute to stability. (vi) Belief dispersion is measured by cross sectional standard deviation of individual beliefs. An increased belief diversity is found to make policy coordination harder and results in lower aggregate output and lower rate of inflation. Bank policy can lower belief dispersion by being more transparent.

Keywords: New Keynesian Model, heterogeneous beliefs, market state of belief, rational beliefs, monetary policy rule

JEL Classification: C530, D800, D840, E270, E420, E520, G120, G140

Suggested Citation

Kurz, Mordecai and Motolese, Maurizio and Piccillo, Giulia and Wu, Howei, Monetary Policy with Diverse Private Expectations (March 30, 2015). CESifo Working Paper Series No. 5252, Available at SSRN: or

Mordecai Kurz

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States

Maurizio Motolese (Contact Author)

Catholic University of Milan ( email )

L.go A. Gemelli, 1
Milano, MI 20123
+39-02-72342418 (Phone)

Giulia Piccillo

Maastricht University ( email )

P.O. Box 616
Maastricht, 6200 MD

Liverpool University ( email )

Eleanor Rathbone Building
Bedford Street North
Liverpool L69 7ZA
United Kingdom

Utrecht University - School of Economics ( email )

Kriekenpitplein 21-22
Adam Smith Building
Utrecht, +31 30 253 7373 3584 EC

Howei Wu

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433

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