Learning, Inflation Expectations and Optimal Monetary Policy

Bank of Finland Discussion Paper No. 20/2003

53 Pages Posted: 22 Oct 2003

See all articles by Eric Schaling

Eric Schaling

Rand Afrikaans University - Department of Economics; Bank of England

Date Written: August 18, 2003

Abstract

In this paper we analyse disinflation policy in two environments. In the first, the central bank has perfect knowledge, in the sense that it understands and observes the process by which private sector inflation expectations are generated; in the second, the central bank has to learn the private sector inflation forecasting rule. With imperfect knowledge, results depend on the learning scheme that is employed. Here, the learning scheme we investigate is that of least-squares learning (recursive OLS) using the Kalman filter. A novel feature of a learning-based policy - as against the central bank's disinflation policy under perfect knowledge - is that the degree of monetary accommodation (the extent to which the central bank accommodates private sector inflation expectations) is no longer constant across the disinflation, but becomes state-dependent. This means that the central bank's behaviour changes during the disinflation as it collects more information.

Keywords: Learning, rational expectations, separation principle, Kalman filter, time-varying parameters, optimal control

JEL Classification: C53, E43, E52, F33

Suggested Citation

Schaling, Eric, Learning, Inflation Expectations and Optimal Monetary Policy (August 18, 2003). Bank of Finland Discussion Paper No. 20/2003, Available at SSRN: https://ssrn.com/abstract=444541 or http://dx.doi.org/10.2139/ssrn.444541

Eric Schaling (Contact Author)

Rand Afrikaans University - Department of Economics ( email )

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