TY  - JOUR
AU  - Orphanides, Athanasios
AU  - Williams, John C
TI  - Imperfect Knowledge, Inflation Expectations, and Monetary Policy
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 9884
PY  - 2003
Y2  - August 2003
DO  - 10.3386/w9884
UR  - http://www.nber.org/papers/w9884
L1  - http://www.nber.org/papers/w9884.pdf
N1  - Author contact info:
Athanasios Orphanides
Sloan School of Management
Massachusetts Institute of Technology
77 Massachusetts Avenue
Cambridge, MA 02139
E-Mail: athanasios.orphanides@gmail.com

John Williams
Federal Reserve Bank of San Francisco
Executive Offices
101 Market St.
San Francisco, CA 94105
Tel: (415) 974-2121
E-Mail: john.c.williams@sf.frb.org
M1  - published as Athanasios Orphanides, John Williams. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," in Ben S. Bernanke and Michael Woodford, editors, "The Inflation-Targeting Debate" University of Chicago Press (2005)

AB  - This paper investigates the role that imperfect knowledge about the structure of the economy plays in the formation of expectations, macroeconomic dynamics, and the efficient formulation of monetary policy. Economic agents rely on an adaptive learning technology to form expectations and to update continuously their beliefs regarding the dynamic structure of the economy based on incoming data. The process of perpetual learning introduces an additional layer of dynamic interaction between monetary policy and economic outcomes. We find that policies that would be efficient under rational expectations can perform poorly when knowledge is imperfect. In particular, policies that fail to maintain tight control over inflation are prone to episodes in which the public's expectations of inflation become uncoupled from the policy objective and stagflation results, in a pattern similar to that experienced in the United States during the 1970s. Our results highlight the value of effective communication of a central bank's inflation objective and of continued vigilance against inflation in anchoring inflation expectations and fostering macroeconomic stability.
ER  -