Heterogeneous Expectations, Taylor Rules And The Merit Of Monetary Policy Inertia
The authors present new results for the performance of Taylor rules in a New Keynesian model with heterogeneous expectations. Agents have either rational or adaptive expectations. They find that depending on the particular rule, expectational heterogeneity can create or increase the set of policies that leads to local explosiveness. This is a new level of destabilization compared to what is known. In addition, they demonstrate that policy inertia is an effective tool to safeguard the economy against local explosiveness. Thus, they provide a rationalization for central banks to adjust interest rates with notable inertia in response to shocks.