Learning and optimal monetary policy

Dennis, R. and Ravenna, F. (2008) Learning and optimal monetary policy. Journal of Economic Dynamics and Control, 32(6), pp. 1964-1994. (doi:10.1016/j.jedc.2007.08.002)

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Abstract

To conduct policy efficiently, central banks must use available data to infer, or learn, the relevant structural relationships in the economy. However, because a central bank's policy affects economic outcomes, the chosen policy may help or hinder its efforts to learn. This paper examines whether real-time learning allows a central bank to learn the economy's underlying structure and studies the impact that learning has on the performance of optimal policies under a variety of learning environments. Our main results are as follows. First, when monetary policy is formulated as an optimal discretionary targeting rule, we find that the rational expectations equilibrium and the optimal policy are real-time learnable. This result is robust to a range of assumptions concerning private-sector learning behavior. Second, when policy is set with discretion, learning can lead to outcomes that are better than if the model parameters are known. Finally, if the private sector is learning, then unannounced changes to the policy regime, particularly changes to the inflation target, can raise policy loss considerably.

Item Type:Articles
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Dennis, Professor Richard
Authors: Dennis, R., and Ravenna, F.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:Journal of Economic Dynamics and Control
Publisher:Elsevier
ISSN:0165-1889

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