Heterogeneous Expectations, Adaptive Learning,and Forward-Looking Monetary Policy

Release date
01/05/2008
Reference
DP2008/07
Author
Martin Fukac

In this paper, I examine the role of monetary policy in a heterogeneous expectations environment. I use a New Keynesian business cycle model as the experiment laboratory. I assume that the central bank and private economic agents (households and producing firms) have imperfect and heterogeneous information about the economy, and as a consequence, they disagree in their views on its future development. I facilitate the heterogeneous environment by assuming that all agents learn adaptively. Measured by the central bank's expected loss, the two major findings are - (i) policy that is efficient under homogeneous expectations is not efficient under heterogeneous expectations; (ii) in the short and medium run, policy that is excessively responsive to infiation increases infation and output volatility, but in the long run such policy lowers economic volatility.