Learning About Inflation Measures for Interest Rate Rules

Author/Editor:

Luis-Felipe Zanna ; Marco Airaudo

Publication Date:

December 1, 2010

Electronic Access:

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Summary:

Empirical evidence suggests that goods are highly heterogeneous with respect to the degree of price rigidity. We develop a DSGE model featuring heterogeneous nominal rigidities across two sectors to study the equilibrium determinacy and stability under adaptive learning for interest rate rules that respond to inflation measures differing in their degree of price stickiness. We find that rules responding to headline inflation measures that assign a positive weight to the inflation of the sector with low price stickiness are more prone to generate macroeconomic instability than rules that respond exclusively to the inflation of the sector with high price stickiness. By this we mean that they are more prone to induce non-learnable fundamental-driven equilibria, learnable self-fulfilling expectations equilibria, and equilibria where fluctuations are unbounded. We discuss how our results depend on the elasticity of substitution across goods, the degree of heterogeneity in price rigidity, as well as on the timing of the rule.

Series:

Working Paper No. 10/296

Subject:

English

Publication Date:

December 1, 2010

ISBN/ISSN:

9781455211777/1018-5941

Stock No:

WPIEA2010296

Format:

Paper

Pages:

45

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