Learning the Inflation Target
34 Pages Posted: 28 Apr 2005
Date Written: September 2004
The New Keynesian model with rational expectations unrealistically predicts that unanticipated credible changes in the inflation target lead to an immediate jump in the inflation level while the output gap is unaffected. We set up a theoretical model where agents learn the behaviour of the economy. In this context, a permanent change in the inflation target leads inflation to respond sluggishly while the output gap is temporarily affected. We extend the model to allow for both learners and forward looking agents to coexist. The calibrated model explains quite well transition dynamics during the Volker disinflation.
Keywords: Learning, Policy shifts, Volker disinflation
JEL Classification: D83, E31, E52
Suggested Citation: Suggested Citation