Social Learning and Monetary Policy at the Effective Lower Bound

This research develops a model in which the economy is directly influenced by how pessimistic or optimistic economic agents are about the future. The agents may hold different views and update them as new economic data become available.

Using US data, the model accounts for several key features of macroeconomic data and data from expectation surveys of professional forecasters. In particular, the model reproduces prolonged episodes of below-target inflation coupled with near-zero interest rates resembling the recent economic experience since the 2008 crisis. Following an external shock that decreases output or inflation, agents lower their inflation and output outlooks. Their pessimistic views become self-confirming and inflation is locked into a below-target level.

Central banks can release information to help agents coordinate their economic views on higher inflation levels. However, this communication comes with a risk of credibility loss. On the one hand, if actual inflation is low, agents may not believe a central bank’s message about higher future inflation or targets. On the other hand, true forecasts of low future inflation can create a risk of self-confirming pessimism: the agents will adopt the central bank’s views and keep on expecting  below-target inflation. Either way, communicating reduces the heterogeneity of agents’ views but does not solve the issue of persistently low inflation and interest rates.