Work detail

Role of Expectations in Monetary Policy

Author: Mgr. Jan Filáček, Ph.D.
Year: 2004 - summer
Leaders: prof. Ing. Miloslav Vošvrda CSc.
Work type: Dissertations
Language: Czech
Pages: 93
Awards and prizes:
Abstract: This paper focuses on the role of expectations in the conduct of monetary policy. In the first part I identify the expectation of inflation as a main economic variable determining the agents` behavior. For each agent, the estimate of future inflation development is necessary to evaluate the present value of her expected future incomes and optimal intertemporal substitution in her consumption. In this chapter, I further argue that an optimal monetary policy framework for affecting private agents` inflation expectations s explicit and rule/based inflation targeting. Inflation targeting monetary policy framework provides partial warranty of stable inflation development. Moreover, this framework is accompanied with higher monetary policy transparency, which results in better know-how of private agents on the future development of inflation and other key variables of the economy.

The second chapter describes the behavior of a small open economy operating in an inflation targeting regime under different assumptions about private agents` expectations: naive, rational and mixed expectations and adaptive learning. I do so by applying deterministic and stochastic shocks of three different types: demand, supply and exchange rate shocks. The conclusion of the chapter is that rational expectations lead to the least volatile development of the economy and, at the same time, they minimize the central bank's loss function.

In the third chapter I provide the empirical analysis of empirically observed inflation expectations in the Czech Republic, New Zealand, Sweden and the United Kingdom. The major finding drawn from this sample is that empirically observed inflation expectations are far from being rational. Instead, they are strongly persistent and only partially forward/looking. I also find that the extent of forward-lookingness, approximated by the belief in inflation target fulfillment, is country-specific. These results suggest that in all countries in the sample there is a room for a further increase in forward-lookingness (rationality) of inflation expectations, making the economy less sensitive to external shocks and monetary policy more efficient.

The final chapter addresses the ability of the central bank to influence private agents` expectations in more detail. The econometric analysis of domestic inflation expectations` formation indicates the strong role of monetary policy transparency, communication with the public and historical record are identified as major determinants of the central bank's credibility and consequently as major determinants of expectations` forward-lookingness.
Downloadable: Dissertation Thesis - Filáček




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