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On the perils of stabilizing prices when agents are learning

Mele, Antonio; Molnár, Krisztina; Santoro, Sergio
Working paper
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URI
http://hdl.handle.net/11250/274241
Date
2015-01
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  • Discussion papers (SAM) [608]
Abstract
We show that price level stabilization is not optimal in an economy where

agents have incomplete knowledge about the policy implemented and try to

learn it. A systematically more accommodative policy than what agents

expect generates short term gains without triggering an abrupt loss of con-

fidence, since agents update expectations sluggishly. In the long run agents

learn the policy implemented, and the economy converges to a rational expectations

equilibrium in which policy does not stabilize prices, economic

volatility is high, and agents suffer the corresponding welfare losses. However,

these losses are outweighed by short term gains from the learning

phase.
Publisher
SAM
Series
Discussion paper;01/15

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