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Misperceptions and monetary policy in a New Keynesian model

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  • Jarkko Jääskelä
  • Jack McKeown
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    Abstract

    This paper studies the consequences for the monetary policy design of information shortages on the part of the private sector. We model these shortages as exogenous shocks to expected output, which through an IS curve, disturb demand and output themselves. We constrain policymakers to follow Taylor-like rules but allow them to optimise coefficients: we find that the presence of misperceptions makes the optimised Taylor rule respond more aggressively to inflation and the output gap. We also find that if the policymaker is uncertain about misperceptions, then it is less costly to assume they are pervasive when they are not than the reverse. In other words, setting policy on the basis that the private sector is subject to misperceptions is a 'robust' policy

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    Bibliographic Info

    Paper provided by Bank of England in its series Bank of England working papers with number 278.

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    Date of creation: Oct 2005
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    Handle: RePEc:boe:boeewp:278

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    1. Bordo, Michael D & Jeanne, Olivier, 2002. "Boom-Busts in Asset Prices, Economic Instability and Monetary Policy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3398, C.E.P.R. Discussion Papers.
    2. Jeffery D. Amato & Thomas Laubach, 2002. "Rule-of-thumb behaviour and monetary policy," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2002-5, Board of Governors of the Federal Reserve System (U.S.).
    3. William A. Brock & Steven N. Durlauf & Kenneth D. West, 2003. "Policy Evaluation in Uncertain Economic Environments," NBER Working Papers 10025, National Bureau of Economic Research, Inc.
    4. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
    5. Leitemo, Kai & Söderström, Ulf, 2001. "Simple Monetary Policy Rules and Exchange Rate Uncertainty," Working Paper Series 122, Sveriges Riksbank (Central Bank of Sweden).
    6. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, Elsevier, vol. 42(6), pages 1033-1067, June.
    7. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 29(1), pages 173-203, January.
    8. Andrew Levin & Volker Wieland & John C. Williams, 1998. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Working Papers 6570, National Bureau of Economic Research, Inc.
    9. Richard Dennis, 2000. "Solving for optimal simple rules in rational expectations models," Working Paper Series, Federal Reserve Bank of San Francisco 2000-14, Federal Reserve Bank of San Francisco.
    10. Glenn D. Rudebusch, 2000. "Assessing nominal income rules for monetary policy with model and data uncertainty," Working Paper Series, Federal Reserve Bank of San Francisco 2000-03, Federal Reserve Bank of San Francisco.
    11. John C. Williams & Andrew T. Levin, 2003. "Robust Monetary Policy with Competing Reference Models," Computing in Economics and Finance 2003, Society for Computational Economics 291, Society for Computational Economics.
    12. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, American Economic Association, vol. 91(2), pages 253-257, May.
    13. Athanasios Orphanides & John C. Williams, 2002. "Robust Monetary Policy Rules with Unknown Natural Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 63-146.
    14. Charles R. Bean, 2004. "Asset Prices, Financial Instability, and Monetary Policy," American Economic Review, American Economic Association, American Economic Association, vol. 94(2), pages 14-18, May.
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