Optimal Monetary Policy Under Adaptive Learning

Average inflation targeting is being actively discussed by central banks, academic and expert communities as a measure that can improve the effectiveness of monetary policy. The main perceived advantage of this policy is higher inflation expectations during recessions and, as a consequence, a possible faster recovery of the economy during crises. Such reasoning, as a rule, is based on the assumption of rational expectations. However, in practice, private agent’s expectations are far from full rationality. As empirical studies show, economic agents are more likely to be inclined to some adaptivity of expectations and learning. This work sheds light on how the effects of the transition to average inflation targeting change when the assumptions of rational expectations is abandoned in favor of the assumption of adaptive learning. The paper demonstrates that under adaptive learning the transition to average inflation targeting is the desirable only if private agents correctly percieve the structure of the economy and central bank's reaction function. In other case, the perils of the transition to average inflation targeting raises doubts. Keywords: monetary policy, expectations, average inflation. JEL: E31, E52, E58.