Learning about Monetary Policy Rules when Long-Horizon Expectations Matter
by Bruce Preston
This paper considers the implications of an important
source of model misspecification for the design of monetary
policy rules: the assumed manner of expectations formation.
In the model considered here, private agents seek to maximize
their objectives subject to standard constraints and the restriction
of using an econometric model to make inferences about
future uncertainty. Because agents solve a multiperiod decision
problem, their actions depend on forecasts of macroeconomic
conditions many periods into the future, unlike the analysis of
Bullard and Mitra (2002) and Evans and Honkapohja (2002).
A Taylor rule ensures convergence to the rational expectations
equilibrium associated with this policy if the so-called Taylor
principle is satisfied. This suggests the Taylor rule to be desirable
from the point of view of eliminating instability due to
JEL Codes: E52, D83, D84.
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