CFS Working Paper No . 2008 / 17 Learning , Endogenous Indexation and Disinflation in the New-Keynesian Model * (original) (raw)

Expectation, learning, and the costs of disinflation.pdf

The macroeconomic costs of disinflation are considered for the United States in a rational expectations macroeconometric model with sticky prices and imperfect information regarding monetary policy objectives. The analysis centers on simulation experiments using the Board's new quarterly macroeconometric model, FRB/US, within which are nested both expectations formation that is 'rational' (i.e., model consistent) and 'restricted-information rational' (i.e., where the information set is restricted to that captured by a small-scale VAR model). We characterize monetary policy as being governed by rules. Disinflations are represented by changes in the target inflation rate of a interest-rate reaction function. Two kinds of rules are considered: a version of the Taylor rule and the other being a more aggressive and richer specification estimated using data for the last 15 years. We assume agents are not fully cognizant of changes in the Fed's inflation target and must instead adjust their perceptions of the target according to a linear updating rule. Simulation results for sacrifice ratios are compared with results from other models and with econometric results and calculations reported in the literature.

Inflation Expectations, Adaptive Learning and Optimal Monetary Policy

Handbook of Monetary Economics, 2010

This chapter investigates the implications of adaptive learning in the private sector's formation of inflation expectations for the conduct of monetary policy. We analyze the determinants of optimal monetary policy in the standard New Keynesian model, when the central bank minimizes an explicit loss function and has full information about the structure of the economy, including the precise mechanism generating private sector's expectations. The focus on optimal policy allows us to investigate how and to what extent a change in the assumption of how agents form their inflation expectations affects the principles of optimal monetary policy. It also provides a benchmark to evaluate simple policy rules. We find that departures from rational expectations increase the potential for instability in the economy, thereby strengthening the importance of managing (anchoring) inflation expectations. We also find that the simple commitment rule under rational expectations is robust when expectations are formed in line with adaptive learning.

Sounding the Alarm on Inflation Indexing and Strict Inflation Targeting

Macroeconomics, 2003

Unanticipated inflation or deflation causes one party of a nominal contract to gain at the expense of the other party, an effect absent in macroeconomic models with one representative consumer or with consumers having identical consumption. In this paper's general dynamic and ...

Inflation targeting in a learning economy: An ABM perspective

2012

0 )5 .5 6 . 8 4 .8 6 .4 7 -w w w . g r e t h a .f r Ciblage de l'inflation dans une économie d'apprentissage : une perspective ABM Résumé La présente contribution analyse les performances d'un régime de ciblage de l'inflation dans une économie, dont le fonctionnement est caractérisé par l'apprentissage des agents qui la peuplent. Ce fonctionnement est traduit en termes d'une modélisation à base d'agents (ABM). Dans un modèle dont la structure reste proche de celle du cadre d'analyse Nouveau Keynésien, nous représentons des agents individuels dont les comportements sont guidés par une rationalité procédurale, au sens de ). Ces comportements se traduisent par l'adoption de règles simples -dites aussi routines, ou heuristiques, plutôt que par la résolution de programmes d'optimisation intertemporelle, nécessitant le recours à l'hypothèse d'anticipations rationnelles. Un processus d'apprentissage perpétuel permet de faire évoluer et d'adapter continuellement ces règles de comportement. Les déviations vis-à-vis de l'équilibre en anticipations rationnelles du modèle émergent de ces comportements d'apprentissage, de manière endogène. Dans ce modèle, la banque centrale met en oeuvre un régime de ciblage de l'inflation via une règle de politique monétaire. Notre objectif est d'analyser les interactions entre les mécanismes d'apprentissage, qui opèrent au niveau individuel, et les caractéristiques et les performances macroéconomiques du régime de ciblage de l'inflation. Nous montrons que la crédibilité des annonces de la banque centrale à propos de ses objectifs joue un rôle primordial dans la stabilisation macroéconomique, et nous mettons en évidence le rôle d'ancrage des anticipations d'inflation privées joué par la cible. Nous pointons aussi l'existence d'un coût potentiel en termes de bien-être à la divulgation d'informations publiques imparfaites, et nous contribuons par ailleurs au débat concernant les règles de politique monétaire optimales dans un contexte d'incertitude. Mots-clés : Ciblage de l'inflation ; modèle à base d'agents ; communication de la banque centrale ; anticipations ; apprentissage

Anchoring Heuristic Messes with Inflation Targeting

Open Access Library Journal, 2015

We evaluate recent inflation-targeting using Brazilian data and also consider the framework of the macroeconomic model of adaptive learning blended with a cognitive psychology approach. We suggest that forecasters interpret the inflation target as an anchor, and adjust to it accordingly. As current inflation increases above the target level, a central bank loses credibility, and forecasters start the adjustment from the top because they expect an even higher future inflation. Then, they move back to the core target within a range of uncertainty, but the adjustment is likely to end before the core is reached, as predicted by the psychological theory of anchors. After calibrating the model, we find an asymptotic equilibrium of a 6.1 percent inflation rate, which overshoots the announced target inflation core of 4.5 percent. This example casts doubt on the very justification for inflation targeting, which is unlikely to succeed when private forecasters rely on anchoring heuristics.

Price-Setting Behavior and Inflation Dynamics

2003

The Calvo (1983) price-setting assumption underlying the New Keynesian Phillips Curve (NKPC) enables much tractability, but implies that some firms may never adjust their price to shocks. In this paper we make the assumption that price-setting behaviour is identical to Calvo except that all firms adjust their prices after a finite period (the 'truncated-Calvo' model). We characterize inflation dynamics of this economy and examine the consequences of estimating the NKPC and the hybrid-NKPC using simulated data. Our results indicate (i) a model where all firms adjust their prices after 12 quarters is empirically indistinguishable from the NKPC; (ii) when all firms adjust prices within 3 to 5 quarters we find evidence for a significant role of lagged inflation, as in Dotsey . However, the support for the hybrid specification itself is mixed. Our findings suggest that forward-looking models that generate lagged inflation dynamics might be empirically relevant.

Precautionary Learning and Inflationary Biases

Recursive least squares learning is a central concept employed in selecting amongst competing outcomes of dynamic stochastic economic models. In employing least squares estimators, such learning relies on the assumption of a symmetric loss function defined over estimation errors. Within a statistical decision making context, this loss function can be understood as a second order approximation to a von-Neumann Morgenstern utility function. This paper considers instead the implications for adaptive learning of a third order approximation. The resulting asymmetry leads the estimator to put more weight on avoiding mistakes in one direction as opposed to the other. As a precaution against making a more costly mistake, a statistician biases his estimates in the less costly direction by an amount proportional to the variance of the estimate. We investigate how this precautionary bias will affect learning dynamics in a model of inflationary biases. In particular we find that it is possible to maintain a lower long run inflation rate than could be obtained in a time consistent rational expectations equilibrium. * We would like to thank seminar participants at the 2005 Southern Economics Association meetings and at the Federal Reserve Bank of Dallas for comments. All remaining errors are ours.

Backward-looking indexation, credibility and inflation persistence

Journal of International Economics, 2001

Inflation persistence is a stylized fact after disinflation. Standard staggered-prices models show very little or no inflation persistence and, hence, are of little use when inflation is sticky. In this paper, I present a model that, on the one hand, is consistent with the evidence of sticky inflation and, on the other, can be directly incorporated into modern intertemporal optimizing

Trust, but verify. De-anchoring of inflation expectations under learning and heterogeneity

2017

The paper studies how a prolonged period of subdued price developments may induce a de-anchoring of inflation expectations from the central bank's objective. This is shown within a framework where agents form expectations using adaptive learning, choosing among a set of alternative forecasting models. The analysis is accompanied by empirical evidence on the properties of inflation expectations in the euro area. Our results also suggest that monetary policy may lose effectiveness if delayed too much, as expectations are allowed to drift away from target for too long. JEL Classification: E31, E37, E58, D83