- Inflation targeting, recursive inattentiveness and heterogeneous beliefs
- Number of pages
- Amsterdam: Universiteit van Amsterdam
- CeNDEF Working Papers
- Volume | Edition (Serie)
- Document type
- Working paper
- Faculty of Economics and Business (FEB)
- Amsterdam School of Economics Research Institute (ASE-RI)
In this paper we consider a scenario in which the monetary authority provides an explicit in ation target in order to anchor private sector expectations and align them with policy objectives. In this context, a biased perception of the target may arise due to imperfect information ows and idiosyncrasies in information processing lead to heterogenous beliefs about the target. We allow private sector expectations to be revised over time as new information becomes available and the direction of change is determined by the distance between agents' beliefs and actual realizations
of macro variables. The recursive choice between alternative predictors is modeled as an optimization problem under rational inattention. Within this framework we investigate whether a simple interest rate rule can steer the economy toward the targeted equilibrium. Our ndings suggest that standard policy advices, i.e., ensure determinacy under rational expectations, may not be sucient to reach the target. Instead, a sound monetary policy should be ne-tuned to ensure that the signal sent by realizations of macro variables can correct biased agents' beliefs.
- August 27, 2014
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