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Robustly optimal monetary policy in a microfounded New Keynesian model

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  • Adam, Klaus
  • Woodford, Michael

Abstract

We consider optimal monetary stabilization policy in a New Keynesian model with explicit microfoundations, when the central bank recognizes that private-sector expectations need not be precisely model-consistent, and wishes to choose a policy that will be as good as possible in the case of any beliefs close enough to model-consistency. We show how to characterize robustly optimal policy without restricting consideration a priori to a particular parametric family of candidate policy rules. We show that robustly optimal policy can be implemented through commitment to a target criterion involving only the paths of inflation and a suitably defined output gap, but that a concern for robustness requires greater resistance to surprise increases in inflation than would be considered optimal if one could count on the private sector to have “rational expectations.”

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 59 (2012)
Issue (Month): 5 ()
Pages: 468-487

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Handle: RePEc:eee:moneco:v:59:y:2012:i:5:p:468-487

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Web page: http://www.elsevier.com/locate/inca/505566

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Keywords: Robust control; Near-rational expectations; Belief distortions; Target criterion;

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References

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  1. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
  2. Michael Woodford, 2005. "Robustly Optimal Monetary Policy with Near Rational Expectations," NBER Working Papers 11896, National Bureau of Economic Research, Inc.
  3. Pierpaolo Benigno & Luigi Paciello, 2010. "Monetary Policy, Doubts and Asset Prices," EIEF Working Papers Series 1024, Einaudi Institute for Economics and Finance (EIEF), revised Sep 2010.
  4. Adam, Klaus & Billi, Roberto M., 2004. "Optimal monetary policy under commitment with a zero bound on nominal interest rates," Working Paper Series 0377, European Central Bank.
  5. Michael Woodford & Pierpaolo Benigno, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," 2004 Meeting Papers 481, Society for Economic Dynamics.
  6. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  7. Giannoni, Marc & Woodford, Michael, 2010. "Optimal Target Criteria for Stabilization Policy," CEPR Discussion Papers 7719, C.E.P.R. Discussion Papers.
  8. Thomas J. Sargent & Riccardo Colacito & Lars P. Hansen & Timothy Cogley, 2008. "Robustness and US Monetary," 2008 Meeting Papers 228, Society for Economic Dynamics.
  9. Hansen, Lars Peter & Sargent, Thomas J., 2005. "Robust estimation and control under commitment," Journal of Economic Theory, Elsevier, vol. 124(2), pages 258-301, October.
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Citations

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Cited by:
  1. Driscoll, John C. & Holden, Steinar, 2014. "Behavioral Economics and Macroeconomic Models," Finance and Economics Discussion Series 2014-43, Board of Governors of the Federal Reserve System (U.S.).
  2. Michael Woodford, 2013. "Macroeconomic Analysis without the Rational Expectations Hypothesis," NBER Working Papers 19368, National Bureau of Economic Research, Inc.
  3. Frank Hespeler & Marco M. Sorge, 2013. "Does Near-Rationality Matter in First-Order Approximate Solutions? A Perturbation Approach," CSEF Working Papers 339, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.

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