Adaptive Learning, Persistence, And Optimal Monetary Policy

The authors show that, when private sector expectations are determined in line with adaptive learning, optimal policy responds persistently to cost-push shocks. The optimal response is stronger and more persistent; the higher is the initial level of perceived inflation persistence by the private sector. Such a sophisticated policy reduces inflation persistence and inflation volatility at little cost in terms of output gap volatility. Persistent responses to cost-push shocks and stability of inflation expectations resemble optimal policy under commitment and rational expectations. Nevertheless, it is clear that the mechanism at play is very different.