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PRECAUTIONARY LEARNING AND INFLATIONARY BIASES

Published online by Cambridge University Press:  14 November 2018

Chetan Dave  and
James Feigenbaum
Chetan Dave*
Affiliation:
University of Alberta
James Feigenbaum
Affiliation:
Utah State University
*
Address correspondence to: Chetan Dave, Department of Economics, University of Alberta, 8-14 HM Tory Building, Edmonton, Alberta, Canada T6G 2H4. e-mail: cdave@ualberta.ca.
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Abstract

In a canonical monetary policy model in which the central bank learns about underlying fundamentals by estimating the parameters of a Phillips curve, we show that the bank’s loss function is asymmetric such that parameter overestimates may be more or less costly than underestimates, creating a precautionary motive in estimation. This motive suggests the use of a more efficient variance-adjusted least-squares estimator for learning about fundamentals. Informed by this “precautionary learning” the central bank sets low inflation targets, and the economy can settle near a Ramsey equilibrium.

Keywords

Asymmetric Least SquaresAdaptive LearningTime ConsistencyInflationary Biases
Type
Articles
Information
Macroeconomic Dynamics , Volume 24 , Issue 5 , July 2020 , pp. 1124 - 1150
Copyright
© Cambridge University Press 2018

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Footnotes

We thank Jess Benhabib, John Duffy, John Leahy, Tom Sargent, and colleagues and seminar participants at New York University (Abu Dhabi), the Southern Economics Association Conference, Society for Nonlinear Dynamics and Econometrics Conference, the Federal Reserve Banks of Dallas and Richmond, and the Computational Economics and Finance Conference for insightful comments and support. The usual disclaimer applies.

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