DP3962 Adaptive Learning and Monetary Policy Design

Author(s): George W. Evans, Seppo Honkapohja
Publication Date: July 2003
Keyword(s): adaptive learning, commitment, determinacy, expectations shocks, interest rate setting, stability
JEL(s): D84, E31, E52
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3962

We review the recent work on interest rate setting, which emphasizes the desirability of designing policy to ensure stability under learning. Appropriately designed expectations-based rules can yield optimal rational expectations equilibria that are both determinate and stable under learning. Some simple instrument rules and approximate targeting rules also have these desirable properties. We discuss various complications in implementing optimal policy, including the observability of key variables and the required knowledge of structural parameters. An additional issue that we take up concerns the implications of expectation shocks not arising from transitional learning effects.