Abstract
We enrich the ECB’s modeling toolkit by incorporating model-consistent expectations into the workhorse projection model, ECB-BASE. This enables analysis of announced policy shifts and anticipation effects. We nest VAR expectations, model-consistent expectations and several combinations of the two, termed as hybrid settings. In addition, the Dynare computational environment has been advanced in several dimensions to enable these new modeling capabilities. We then examine monetary policy implications of varying expectation formation. Simulations indicate that forward-looking expectations result in smoother output responses but front-loaded price reactions to policy shocks. By applying the model to assess recent supply shocks that have led to a surge in inflation, we find that forward-looking expectations from the private sector imply increased macroeconomic volatility, necessitating an early policy response.
Authors
- Stéphane Adjemian
- Nikola Bokan
- Matthieu Darracq Pariès
- Georg Müller
- Srečko Zimic
JEL codes
- C3
- C5
- E1
- E2
- E5