Discussion Paper Details

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Title: Expectations, Learning and Monetary Policy: An Overview of Recent Rersearch

Author(s): George W. Evans and Seppo Honkapohja

Publication Date: January 2008

Keyword(s): determinacy, fluctuations, imperfect knowledge, interest-rate setting, learning and stability

Programme Area(s): International Macroeconomics

Abstract: Expectations about the future are central for determination of current macroeconomic outcomes and the formulation of monetary policy. Recent literature has explored ways for supplementing the benchmark of rational expectations with explicit models of expectations formation that rely on econometric learning. Some apparently natural policy rules turn out to imply expectational instability of private agents' learning. We use the standard New Keynesian model to illustrate this problem and survey the key results about interest-rate rules that deliver both uniqueness and stability of equilibrium under econometric learning. We then consider some practical concerns such as measurement errors in private expectations, observability of variables and learning of structural parameters required for policy. We also discuss some recent applications including policy design under perpetual learning, estimated models with learning, recurrent hyperinflations, and macroeconomic policy to combat liquidity traps and deflation.

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Bibliographic Reference

Evans, G and Honkapohja, S. 2008. 'Expectations, Learning and Monetary Policy: An Overview of Recent Rersearch'. London, Centre for Economic Policy Research.