Endogenous uncertainty and optimal monetary policy
In the so-called new neoclassical synthesis, expected future output and inflation enter the model equations for demand and supply, since house- holds and firms take into account forecasts of endogenous variables in their consumption and pricing decisions. However, the linear model equations of the new neoclassical synthesis reflect the behavior of risk-neutral eco- nomic subjects and firms, since market participants are indifferent to devi- ations of actual values of endogenous variables from previously predicted levels, which is in contrast to the risk-aversion reflected in the utility func- tions used in the underlying microfoundation. In this paper, we show that risk-averse economic subjects and firms form rational expectations not only regarding the expected values but also regarding uncertainty in future variables, impacting the model equations for demand and supply and the conduct of monetary policy (JEL D81, E10, E52).
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