Monetary policy & anchored expectations—An endogenous gain learning model

Abstract

Monetary policy is analyzed in a model with a potential unanchoring of inflation expectations. The degree of unanchoring is given by how sensitively the public’s long-run inflation expectations respond to inflation surprises. I find that optimal policy moves the interest rate aggressively when expectations unanchor, allowing the central bank to accommodate inflation fluctuations when expectations are well-anchored. Furthermore, I estimate the model-implied unanchoring process. The data suggest that unanchoring is nonlinear and asymmetric: expectations respond more sensitively to large or downside surprises than to smaller or upside ones.