Signals and learning in a new Keynesian economy

This paper aims at assessing whether, and how, communication of central bank's forecast might affect economic dynamics. In a simple new Keynesian environment it is assumed that private sector conditions its own expectations to central bank's forecasts. Private sector's prior expectations are estimated in each period in accordance with the adaptive learning scheme, and successively updated with a signal based on central bank's forecasts. Using both analytical and numerical calculations it is shown that the economy's dynamics is affected by central bank's ability to correctly assess the effect of the signal. In particular, if the central bank takes into account the impact of signals on private agents' expectations the economic dynamics is less volatile. Moreover, if a fundamentals based signal includes a stochastic component unrelated to the economy, the strategy of communicating expectations to the private sector may perform worst than in the case of a totally uninformative signal. (C) 2014 Elsevier Inc. All rights reserved.