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Optimal Monetary Policy under Heterogeneous Expectations

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  • Orlando Gomes

    (Escola Superior de Comunicação Social)

Abstract

Monetary policy has an important role in the determination of the inflation rate and the output gap time trajectories. Monetary authorities should choose the nominal interest rate time path that best serves the goals of price stability (primarily) and output growth (as a consequence of the first). In this paper it is presented a framework under which an optimal interest rate rule is computed, and this rule is found to be stabilizing. The stability result is true for a homogeneous expectations scenario, where all individuals believe that inflation converges to a long run low level. Introducing expectations heterogeneity under a bounded rationality – discrete choice setup, this result continues to hold, but now we cannot exclude periods of strong price instability that, nevertheless, do not tend to persist for long periods of time.

Suggested Citation

  • Orlando Gomes, 2004. "Optimal Monetary Policy under Heterogeneous Expectations," Macroeconomics 0409023, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpma:0409023
    Note: Type of Document - pdf; pages: 32
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    File URL: https://econwpa.ub.uni-muenchen.de/econ-wp/mac/papers/0409/0409023.pdf
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    References listed on IDEAS

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    2. Sophocles N. Brissimis & Nicholas S. Magginas, 2017. "Monetary Policy Rules Under Heterogeneous Inflation Expectations," Economic Inquiry, Western Economic Association International, vol. 55(3), pages 1400-1415, July.

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    More about this item

    Keywords

    Optimal monetary policy; Price stability; Inflation targeting; Heterogeneous expectations; Bounded rationality; Discrete choice;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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