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Rule-Based Monetary Policy under Central Bank Learning

In: NBER International Seminar on Macroeconomics 2004

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  • Kosuke Aoki
  • Kalin Nikolov

Abstract

This paper evaluates the performance of three popular monetary policy rules where the central bank is learning about the parameter values of a simple New Keynesian model. The three policies are: (1) the optimal non-inertial rule; (2) the optimal history-dependent rule; (3) the optimal price level targeting rule. Under rational expectations rules (2) and (3) both implement the fully optimal equilibrium by improving the output/inflation trade-off. When imperfect information about the model parameters is introduced, the central bank makes monetary policy mistakes, which affect welfare to a different degree under the three rules. The optimal history-dependent rule is worst affected and delivers the lowest welfare. Price level targeting performs best under learning and maintains the advantages of conducting policy under commitment. These findings are related to the literature on feedback control and robustness. The paper argues that adopting integral representations of rules designed under full information is desirable, because these rules deliver the beneficial output/inflation trade-off of commitment policy, while being robust to implementation errors.

(This abstract was borrowed from another version of this item.)

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This chapter was published in:

  • Richard H. Clarida & Jeffrey Frankel & Francesco Giavazzi & Kenneth D. West, 2006. "NBER International Seminar on Macroeconomics 2004," NBER Books, National Bureau of Economic Research, Inc, number clar06-1, octubre-d.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 0082.

    Handle: RePEc:nbr:nberch:0082

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    References

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    1. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
    2. Athanasios Orphanides & John C. Williams, 2002. "Imperfect knowledge, inflation expectations, and monetary policy," Finance and Economics Discussion Series 2002-27, Board of Governors of the Federal Reserve System (U.S.).
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