A note on expectational stability under non-zero trend inflation

Kobayashi, Teruyoshi and Muto, Ichiro (2010): A note on expectational stability under non-zero trend inflation.

Abstract

This study examines the expectational stability of the rational expectations equilibria (REE) under alternative Taylor rules when trend inflation is non-zero. We find that when trend inflation is high, the REE is likely to be expectationally unstable. This result holds true regardless of the nature of the data (such as contemporaneous data, forecast, and lagged data) introduced in the Taylor rule. Our results suggest that a high macroeconomic volatility during the period of high trend inflation can be well explained by introducing the concept of expectational stability.

• Item Type: MPRA Paper
• Language: English
• Keywords: adaptive learning, E-stability, Taylor rule, trend inflation
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D84 - Expectations ; Speculations; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

Ascari, G., 2004, Staggered prices and trend inflation: some nuisances. Review of Economic Dynamics 7, 642-667.

Ascari, G. and T. Ropele, 2007, Optimal monetary policy under low trend inflation, Journal of Monetary Economics 54, 2568-83.

Ascari, G. and T. Ropele, 2009, Trend inflation, Taylor principle and indeterminacy, Journal of Money, Credit and Banking 41, issue 8, 1557-84.

Blanchard, O., G. Dell’Ariccia and P. Mauro, 2010, Rethinking macroeconomic policy, IMF Staff Position Note, SPN/10/3.

Bullard, J. and K. Mitra, 2002, Learning about monetary policy rules, Journal of Monetary Economics 49, 1105-29.

Cogley, T. and A.M. Sbordone, 2008, Trend inflation, indexation, and inflation persistence in the new Keynesian Phillips curve, American Economic Review 98, 2101-26.

Coibion, O. and Y. Gorodnichenko, 2010, Monetary policy, trend inflation and the Great Moderation: An alternative interpretation, American Economic Review, forthcoming.

Evans, G.W. and S. Honkapohja, 2001, Learning and Expectations in Macroeconomics. Princeton University Press, Princeton, New Jersey.

Honkapohja, S., 2003, Discussion of Preston, “Learning about monetary policy rules when long-horizon expectations matter,” Federal Reserve Bank of Atlanta Working Paper 2003-19.

Honkapohja, S., K. Mitra and G.W. Evans, 2002, Notes on agents’ behavioral rules under adaptive learning and recent studies of monetary policy. http://darkwing.uoregon.edu/∼gevans.

Kiley, M.T., 2007, Is moderate-to-high inflation inherently unstable? International Journal of Central Banking 3, 173-201.

McCallum, B.T., 1999, Issues in the design of monetary policy rules, in J.B. Taylor and M. Woodford (ed.), Handbook of Macroeconomics vol 1, Part C, 1483-1530.

Preston, B., 2005, Learning about monetary policy rules when long-horizon expectations matter, International Journal of Central Banking 1, 81-126.

Preston, B., 2006, Adoptive learning, forecast-based instrument rules and monetary policy, Journal of Monetary Economics 53, 507-535.

Sbordone, A.M., 2007, Inflation persistence: Alternative interpretation and policy implications, Journal of Monetary Economics 54, 1311-39.