Arbeitspapier

Optimal Constrained Interest-Rate Rules under Heterogeneous Expectations

This paper examines optimal monetary policy under heterogeneous expectations. To this end, we develop a stochastic New Keynesian model with a cost-push shock and coexistence of one-step-ahead rational and adaptive expectations in decentralized markets. On the one side, heterogeneous expectations imply an amplification mechanism that has many adverse consequences missing under the rational expectations paradigm. On the other side, even discretionary optimal monetary policy can manipulate expectations via a novel channel. We argue that the incorporation of heterogeneous expectations in both the design and implemen tation of discretionary optimal monetary policy to exploit this channel lowers macroeconomic volatility. We find that: (1.) surprisingly, a more hawkish policy can reduce losses due to volatility, but an overly hawkish policy does not; (2.) overestimating the share of rational expectations in the design and implementation of policy creates additional losses, while the underestimation does not; (3.) credible commitment eliminates or mitigates many of the ramifications of heterogeneous expectations.

Language
Englisch

Bibliographic citation
Series: ECON WPS - Working Papers in Economic Theory and Policy ; No. 04/2021

Classification
Wirtschaft
Expectations; Speculations
Monetary Policy
Subject
heterogeneous expectations
optimal monetary policy
policy design
policy implementation

Event
Geistige Schöpfung
(who)
Gasteiger, Emanuel
Event
Veröffentlichung
(who)
TU Wien, Institute of Statistics and Mathematical Methods in Economics, Research Unit in Economics
(where)
Vienna
(when)
2021

Handle
Last update
10.03.2025, 11:45 AM CET

Data provider

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Object type

  • Arbeitspapier

Associated

  • Gasteiger, Emanuel
  • TU Wien, Institute of Statistics and Mathematical Methods in Economics, Research Unit in Economics

Time of origin

  • 2021

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