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Journal ArticleDOI

Performance of Monetary Policy with Internal Central Bank Forecasting

TL;DR: In this paper, the implications of heterogeneity across forecasts by the central bank and private agents for the performance of interest-rate rules are studied from a learning perspective, and the authors propose a learning-based approach to evaluate the desirability of different optimal and ad hoc interest rate rules under the assumption that forecasts of the private sector and central bank are homogeneous.
Abstract: Recent models of monetary policy have analysed the desirability of different optimal and ad hoc interest-rate rules under the restrictive assumption that forecasts of the private sector and central bank are homogeneous. In this paper, we study from a learning perspective the implications of heterogeneity across forecasts by the central bank and private agents for the performance of interest-rate rules.

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WORKING PAPER NO. 127
PERFORMANCE OF
MONETARY POLICY WITH
INTERNAL CENTRAL BANK
FORECASTING
BY SEPPO HONKAPOHJA
AND KAUSHIK MITRA
February 2002
EUROPEAN CENTRAL BANK
WORKING PAPER SERIES

WORKING PAPER NO. 127
PERFORMANCE OF
MONETARY POLICY WITH
INTERNAL CENTRAL BANK
FORECASTING
*
BY SEPPO HONKAPOHJA
**
AND KAUSHIK MITRA
***
February 2002
* This work was in part done when the first author visited the European Central Banks Directorate General Research
as part of their Research Visitor Programme and the second author attended the Bank of Finnland as a visiting scholar.
We thank these banks for research support and hospitality. Any views expressed are those of the authors and do not necessarily
constitute the views of the Bank of Finland or the European Central Bank. Support from the Academy of Finland, Bank of Finland,
Yrjö Jahnsson Foundation and Nokia Group is gratefully acknowledged.
** University of Helsinki
*** Royal Holloway College, University of London
EUROPEAN CENTRAL BANK
WORKING PAPER SERIES

© European Central Bank, 2002
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All rights reserved.
Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.
The views expressed in this paper are those of the authors and do not necessarily reflect those of the European Central Bank.
ISSN 1561-0810

ECB Working Paper No 127  February 2002
3
Contents
Abstract 4
Non-technical summary 5
1 Introduction 7
2 Analytical framework 10
3 Heterogenous forecasts under homogenous learning rules 14
4 Heterogenous learning rules 17
4.1 RLS learning with different gain sequences 17
4.1.1 Stability and instability conditions for interest rate rules 19
4.1.2 Robustness of the rules to gain differentials 21
4.2 RLS learning and SG learning 23
4.2.1 Bank uses SG and private agents use RLS 24
4.2.2 Bank uses RLS and private agents use SG 26
5 Asymmetric information between the private sector and central bank 28
6 Discussion and concluding remarks 31
A Appendix 32
A.1 Proof of corollaries 4 and 5 32
A.2 Proof of corollary 10 34
A.3 Proof of corollaries 11 and 12 35
A.4 Proof of proposition 13 37
References 38
European Central Bank Working Paper Series 46

ECB Working Paper No 127  February 2002
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Cites background or methods from "Performance of Monetary Policy with..."

  • ...…as has been examined in a Cobweb model by Brock and Hommes (1997) and found empirically relevant in the data in Branch (2004, 2007); agents may have different information sets (e.g. Mankiw et al., 2003); or, they may use structurally different learning rules as in Honkapohja and Mitra (2005)....

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  • ...28 It has also been emphasized that policy rules should be chosen so that the associated unique equilibrium is stable under learning: see for example, Bullard and Mitra (2002), Honkapohja and Mitra (2005) and Evans and McGough (2005)....

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