Adaptive learning, persistence, and optimal monetary policy

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Adaptive learning, persistence, and optimal monetary policy

Author Info

Vitor Gaspar () (Banco de Portugal, 148 Rua do Comercio, P - 1101 Lisbon Codex, Portugal.)
Frank Smets () (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
David Vestin () (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)

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Abstract

We show that, when private sector expectations are determined in line with adaptive learning, optimal policy responds persistently to cost-push shocks. The optimal response is stronger and more persistent, the higher is the initial level of perceived inflation persistence by the private sector. Such a sophisticated policy reduces inflation persistence and inflation volatility at little cost in terms of output gap volatility. Persistent responses to cost-push shocks and stability of inflation expectations resemble optimal policy under commitment and rational expectations. Nevertheless, it is clear that the mechanism at play is very different. In the case of commitment it relies on expectations of future policy actions affecting inflation expectations; in the case of sophisticated central banking it relies on the reduction in the estimated inflation persistence parameter based on inflation data generated by shocks and policy responses. JEL Classification: E52.

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Paper provided by European Central Bank in its series Working Paper Series with number 644.

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Length: 36 pages
Date of creation: Jun 2006
Date of revision:
Handle: RePEc:ecb:ecbwps:20060644

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Article
- Vitor Gaspar & Frank Smets & David Vestin, 2006. "Adaptive Learning, Persistence, and Optimal Monetary Policy," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 376-385, 04-05. [Downloadable!] (restricted)

This paper has been announced in the following NEP Reports:

NEP-ALL-2006-07-28 (All new papers)
NEP-CBA-2006-07-28 (Central Banking)
NEP-MAC-2006-07-28 (Macroeconomics)
NEP-MON-2006-07-28 (Monetary Economics)

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
Other versions:
- Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
- Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
- Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The Science of Monetary Policy: A New Keynesian Perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999. [Downloadable!]
- Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
Vitor Gaspar & Frank Smets, 2005. "Monetary Policy under Adaptive Learning," Computing in Economics and Finance 2005 80, Society for Computational Economics. [Downloadable!]
Athanasios Orphanides & John C. Williams, 2003. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Working Papers 9884, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
Other versions:
- Athanasios Orphanides & John C. Williams, 2002. "Imperfect knowledge, inflation expectations, and monetary policy," Working Papers in Applied Economic Theory 2002-04, Federal Reserve Bank of San Francisco. [Downloadable!]
- Athanasios Orphanides & John C. Williams, 2003. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," CFS Working Paper Series 2003/40, Center for Financial Studies. [Downloadable!]
- Athanasios Orphanides & John C. Williams, 2002. "Imperfect knowledge, inflation expectations, and monetary policy," Finance and Economics Discussion Series 2002-27, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
- Athanasios Orphanides & John Williams, 2004. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Chapters, in: The Inflation-Targeting Debate, pages 201-246 National Bureau of Economic Research, Inc. [Downloadable!]
Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September. [Downloadable!] (restricted)
Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Working Papers 050608, University of California-Irvine, Department of Economics. [Downloadable!]
Other versions:
- Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Macroeconomics 0510022, EconWPA. [Downloadable!]
- Milani, Fabio, 2007. "Expectations, learning and macroeconomic persistence," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 2065-2082, October. [Downloadable!] (restricted)
Athanasios Orphanides amd John Williams, 2001. "Monetary Policy with Imperfect Knowledge," Computing in Economics and Finance 2001 254, Society for Computational Economics.
Other versions:
- Athanasios Orphanides & John C. Williams, 2005. "Monetary policy with imperfect knowledge," Working Papers in Applied Economic Theory 2005-17, Federal Reserve Bank of San Francisco. [Downloadable!]
- Athanasios Orphanides & John C. Williams, 2005. "Monetary policy with imperfect knowledge," Finance and Economics Discussion Series 2005-51, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
- Athanasios Orphanides & John C. Williams, 2006. "Monetary Policy with Imperfect Knowledge," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 366-375, 04-05. [Downloadable!] (restricted)
Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
Other versions:
- Lars E.O. Svensson, 2002. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Working Papers 118, Princeton University, Department of Economics, Center for Economic Policy Studies.. [Downloadable!]
- Lars E. O. Svensson, 2003. "What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," NBER Working Papers 9421, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09. [Downloadable!] (restricted)
Other versions:
- Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Research series 200210, National Bank of Belgium. [Downloadable!]
Gaspar, Vitor & Smets, Frank, 2002. "Monetary Policy, Price Stability and Output Gap Stabilization," International Finance, Blackwell Publishing, vol. 5(2), pages 193-211, Summer. [Downloadable!] (restricted)
Vitor Gaspar & Frank Smets & David Vestin, 2006. "Optimal Monetary Policy under Adaptive Learning," Computing in Economics and Finance 2006 183, Society for Computational Economics. [Downloadable!]

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