Monetary Policy with Opinionated Markets
Ricardo J. Caballero, Alp Simsek
American Economic Review · 2022 · Volume 112 · Issue 7
Abstract
We build a model in which the Fed and the market disagree about future aggregate demand. The market anticipates monetary policy "mistakes," which affect current demand and induce the Fed to partially accommodate the market's view. The Fed expects to implement its view gradually. Announcements that reveal an unexpected change in the Fed's belief provide a microfoundation for monetary policy shocks. Tantrum shocks arise when the market misinterprets the Fed's belief and overreacts to its announcement. Uncertainty about tantrums motivates further gradualism and communication. Finally, disagreements affect the market's expected inflation and induce a policy trade-off similar to "cost-push" shocks.
Keywords
Search, Learning, Information and Knowledge, Communication, Belief, Unawareness, General Aggregative Models: Keynes, Keynesian, Post-Keynesian, Price Level, Inflation, Deflation, Interest Rates: Determination, Term Structure, and Effects, Financial Markets and the Macroeconomy, Monetary Policy, Central Banks and Their Policies
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