Inflation Expectations and Monetary Policy (in Czech)
Year: 2005 Volume: 55 Issue: 7 -8 Pages: 380-394
Abstract: This paper shows that an economy's behavior differs significantly according to assumptions made on the formation of inflation expectations. We analyzed the behavior of an open economy in a regime of explicit inflation targeting with commitment. The economy is exposed to three different shocks ? demand, supply, and exchange rate ? and its reaction is analyzed under three different assumptions on inflation-expectations formation: naive, rational, and adaptive learning. The economy in which rational expectations were assumed showed the least volatile development and minimized the central bank?s loss function. The stabilizing effect of this forward-looking type of expectation was most evident in the case of supply shock. When naive expectations were assumed, the economy reacted to all shocks with significantly bigger and longer-lasting fluctuations. The worst results were obtained assuming adaptive-learning expectations, where shocks lead to large oscillations and the economy stabilized only several years after the shock.
JEL classification: E31, E37, E52
Keywords: inflation expectation; model simulation; monetary policy
RePEc: http://ideas.repec.org/a/fau/fauart/v55y2005i7-8p380-394.html
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