Expectations and the Stability Problem for Optimal Monetary Policies

U of Oregon Dept. of Economics Working Paper No. 230

33 Pages Posted: 12 Mar 2001

See all articles by George W. Evans

George W. Evans

University of Oregon - Department of Economics; University of St. Andrews - School of Economics and Finance

Seppo Honkapohja

Centre for Economic Policy Research (CEPR); Aalto University School of Business; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Aalto University - School of Business

Multiple version iconThere are 5 versions of this paper

Date Written: November 7, 2000

Abstract

A fundamentals based monetary policy rule, which would be the optimal monetary policy without commitment when private agents have perfectly rational expectations, is unstable if in fact these agents follow standard adaptive learning rules. This problem can be overcome if private expectations are observed and suitably incorporated into the policy maker's optimal rule. These strong results extend to the case in which there is simultaneous learning by the policy maker and the private agents. Our findings show the importance of conditioning policy appropriately, not just on fundamentals, but also directly on observed household and firm expectations.

Keywords: expectations, stability, monetary policy, least squares learning

JEL Classification: E52, C62, D83, C62

Suggested Citation

Evans, George W. and Honkapohja, Seppo and Honkapohja, Seppo, Expectations and the Stability Problem for Optimal Monetary Policies (November 7, 2000). U of Oregon Dept. of Economics Working Paper No. 230, Available at SSRN: https://ssrn.com/abstract=262881 or http://dx.doi.org/10.2139/ssrn.262881

George W. Evans (Contact Author)

University of Oregon - Department of Economics ( email )

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University of St. Andrews - School of Economics and Finance ( email )

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Seppo Honkapohja

Centre for Economic Policy Research (CEPR)

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Aalto University School of Business ( email )

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CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

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Aalto University - School of Business

Finland