Optimal Monetary Policy under Adaptive Learning

We consider optimal policy when private sector expectations are formed through adaptive learning. Earlier research has found that adaptive learning is consistent with empirical evidence on private sector expectations. In this paper, we consider the (admittedly) extreme case of sophisticated central banking, whereby the central bank has full knowledge about the structure of the economy. Our results confirm that the management of inflation expectations is crucial for the conduct of monetary policy. n particular, when the private sector perceives that inflation persistence is high, optimal policy responds strongly to lagged inflation and inflation shocks thereby stabilizing inflation and anchoring inflation expectations. For our parametrization it does so at no cost for output gap stability