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Inflation Targeting and Macroeconomic Stability with Heterogeneous Inflation Expectations

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  • Gilberto Tadeu Lima
  • Mark Setterfield
  • Jaylson Jair da Silveira
Abstract
Drawing on an extensive empirical literature that suggests persistent and time-varying heterogeneity in inflation expectations, this paper embeds two inflation forecasting heuristics–one based on the current rate of inflation, and the second anchored to the official inflation target–in a simple macrodynamic model. Decision makers switch between these forecasting heuristics based on satisficing evolutionary dynamics. We show that convergence toward an equilibrium consistent with the level of output and rate of inflation targeted by policymakers is achieved regardless of whether or not the satisficing evolutionary dynamics that guide the choices agents make between inflation forecasting strategies are subject to noise. We also show that full credulity–a situation where all agents eventually use the forecasting heuristic based on the target rate of inflation–is neither a necessary condition for realization of the inflation target nor an inevitable consequence of the economy’s achievement of this target. These results demonstrate that uncertainty in decision making resulting in norm-based inflation expectations that are both heterogeneous and time-varying need not thwart the successful conduct of macroeconomic policy.

Suggested Citation

  • Gilberto Tadeu Lima & Mark Setterfield & Jaylson Jair da Silveira, 2014. "Inflation Targeting and Macroeconomic Stability with Heterogeneous Inflation Expectations," Journal of Post Keynesian Economics, Taylor & Francis Journals, vol. 37(2), pages 255-279, December.
    • Handle: RePEc:mes:postke:v:37:y:2014:i:2:p:255-279
    DOI: 10.2753/PKE0160-3477370204
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    Cited by:

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    2. Mark Setterfield, 2015. "Won’t Get Fooled Again – Or Will We? Monetary Policy, Model Uncertainty, and ‘Policy Model Complacency’," Working Papers 1516, New School for Social Research, Department of Economics, revised Jan 2016.
    3. Gilberto Tadeu Lima & Mark Setterfield & Jaylson Jair da Silveira, 2017. "The Great Deception: the ‘science’ of monetary policy and the Great Moderation revisited," Working Papers 1729, New School for Social Research, Department of Economics.
    4. Soumya Datta & C. Saratchand, 2021. "Kaleckian conflict inflation with endogenous labor supply," Metroeconomica, Wiley Blackwell, vol. 72(2), pages 238-259, May.
    5. Gilberto Tadeu Lima & Mark Setterfield & Jaylson Jair da Silveira, 2023. "Achieving two policy targets with one policy instrument: heterogeneous expectations, countercyclical fiscal policy, and macroeconomic stabilization at the effective lower bound," Working Papers, Department of Economics 2023_01, University of São Paulo (FEA-USP).
    6. Mark Setterfield, 2014. "Using Interest Rates as the Instrument of Monetary Policy: Beware Real effects, Positive Feedbacks, and Discontinuities," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(70), pages 7-22, June.
    7. Toshio Watanabe, 2023. "Financial dynamics in the medium run," Metroeconomica, Wiley Blackwell, vol. 74(3), pages 632-656, July.

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    More about this item

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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