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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Inflation Expectations and the Transmission of Monetary Policy
John M. Roberts

Abstract: New Keynesian models with sticky prices and rational expectations have a difficult time explaining why reducing inflation usually requires a recession. An explanation for the costliness of reducing inflation is that inflation expectations are less than perfectly rational. To explore this possibility, I estimate the degree of nonrationality implicit in two survey measures of inflation expectations. I find that the surveys reflect an intermediate degree of rationality: Expectations are nether perfectly rational nor as unsophisticated as simple autoregressive models would suggest. I also find that a structural New Keynesian model with expectations formation based on the survey results is able to match closely the empirical costs of reducing inflation.

Keywords: Inflation expectations, monetary policy

Full paper (2897 KB PDF)

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Last update: November 24, 1998