Journal Article

Expectations and the Stability Problem for Optimal Monetary Policies

George W. Evans and Seppo Honkapohja

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 70, issue 4, pages 807-824
Published in print October 2003 | ISSN: 0034-6527
Published online October 2003 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/1467-937X.00268
Expectations and the Stability Problem for Optimal Monetary Policies

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  • Information, Knowledge, and Uncertainy
  • Monetary Policy, Central Banking, and the Supply of Money and Credit

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A fundamentals based monetary policy rule, which would be the optimal monetary policy without commitment when private agents have perfectly rational expectations, is unstable if in fact these agents follow standard adaptive learning rules. This problem can be overcome if private expectations are observed and suitably incorporated into the policy maker's optimal rule. These strong results extend to the case in which there is simultaneous learning by the policy maker and the private agents. Our findings show the importance of conditioning policy appropriately, not just on fundamentals, but also directly on observed household and firm expectations.

Keywords: D84; E52

Journal Article.  9027 words.  Illustrated.

Subjects: Information, Knowledge, and Uncertainy ; Monetary Policy, Central Banking, and the Supply of Money and Credit

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