Monetary Policy in a Model with Misspecified, Heterogeneous and Ever-Changing Expectations

Alberto Locarno
2012 Social Science Research Network  
The applied literature on adaptive learning has mostly focused on small, linear models, with homogenous expectations. In non-linear models heterogeneous expectations prevail and the process through which agents select (and change) a forecasting model becomes a necessary ingredient of the analysis; moreover, the temporary equilibrium of the learning process approaches an asymptotic limit that may be affected by the communication strategies of the monetary policymaker. The objective of this paper
more » ... ctive of this paper is to assess whether in such a model economy the optimal monetary policy exhibits properties that are similar to those found in the literature for small, linear models. The main results are the following: (1) expectations heterogeneity is an intrinsic feature of the economy: no PLM succeeds in ruling out all the other forecasting models; (2) contrary to previous findings, the monetary policymaker has no incentive to adopt highly inflation-averse policies: too strong a reaction to price shocks increases both inflation and output volatility; (3) partial transparency seems to enhance somewhat welfare (but fully transparent policies do not); (4) a higher degree of transparency calls for stronger inflation aversion. JEL Classification: E52, E31, D84.
doi:10.2139/ssrn.2182623 fatcat:ssa6cvn5ubgvhmv76ja5zpmt2q