Global stability of inflation target policies with adaptive agents

Abstract

We study a dynamic equilibrium model in which agents have adaptive expectations and monetary authorities pursue an inflation target. We show how alternative monetary stabilization policies become more effective when fiscal constraints on deficits are implemented, although they are not binding at the equilibrium target. In particular, we show that the inflation target equilibrium can be locally, or even globally, stable for a large class of adaptive learning schemes. We also compare alternative stabilization policies in terms of their stability properties. Commonly postulated conditional Taylor-type rules tend to be dominated by other rules, such as an unconditional Friedman type.