Discussion Paper Series 2008-E-1

Monetary Policy and Learning from the Central Bank's Forecast

Ichiro Muto

We examine the expectational stability (E-stability) of the rational expectations equilibrium (REE) in a simple New Keynesian model in which private agents engage in adaptive learning by referring to the central bank's forecast. In this environment, to satisfy the E-stability condition, the central bank must respond more strongly to the expected inflation rate than the so-called Taylor principle suggests. On the other hand, the central bank's strong reaction to the expected inflation rate raises the possibility of indeterminacy of the REE. In considering these problems, a robust policy is to respond to the current inflation rate to a certain degree.

Keywords: Adaptive Learning; E-stability; New Keynesian Model; Monetary Policy; Taylor principle

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2008 Bank of Japan All Rights Reserved.

Home Japanese Home