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1 results

  • PRECAUTIONARY LEARNING AND INFLATIONARY BIASES

  • Chetan Dave, James Feigenbaum
  • Journal:
    Macroeconomic Dynamics / Volume 24 / Issue 5 / July 2020
    Published online by Cambridge University Press:
    14 November 2018, pp. 1124-1150

  • 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.