Deflationary vs. Inflationary Expectations - A New-Keynesian Perspective with Heterogeneous Agents and Monetary Believes

We expand a standard New-Keynesian model by allowing for a special role of money\nin the inflation and expectations building process. Motivated by the two-pillar\nPhillips curve, we introduce heterogeneous expectations. Thereby a fraction of\nagents forms inflation expectations by observing trend money growth. We show\nthat in the presence of these monetary believers, contractive shocks to the economy produce smoother dynamics for inflation and output. We also find that monetary policy should follow a conventional Taylor rule with contemporaneous inflation and output data, if it is uncertain about the fraction of monetary believers.