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Robustly Optimal Monetary Policy with Near-Rational Expectations

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  • Michael Woodford

    () (Columbia University)

Abstract

The paper considers optimal monetary stabilization policy in a forward-looking model, 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 that are close enough to model-consistency. It is found that commitment continues to be important for optimal policy, that the optimal long-run inflation target is unaffected by the degree of potential distortion of beliefs, and that optimal policy is even more history-dependent than if rational expectations are assumed.

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Bibliographic Info

Paper provided by Center for Financial Studies in its series CFS Working Paper Series with number 2007/12.

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Length: 50 pages
Date of creation: 19 Feb 2007
Date of revision:
Handle: RePEc:cfs:cfswop:wp200712

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Related research

Keywords: Optimal Monetary Policy; Commitment; History-Dependent Policy;

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References

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  1. Athanasios Orphanides & John C. Williams, 2002. "Imperfect knowledge, inflation expectations, and monetary policy," Working Papers in Applied Economic Theory 2002-04, Federal Reserve Bank of San Francisco.
  2. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  3. Vitor Gaspar & Frank Smets, 2005. "Monetary Policy under Adaptive Learning," Computing in Economics and Finance 2005 80, Society for Computational Economics.
  4. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  5. Fabio Maccheroni & Massimo Marinacci & Aldo Rustichini, 2006. "Ambiguity Aversion, Robustness, and the Variational Representation of Preferences," Econometrica, Econometric Society, vol. 74(6), pages 1447-1498, November.
  6. 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.
  7. Vitor Gaspar & Frank Smets & David Vestin, 2006. "Optimal Monetary Policy under Adaptive Learning," Computing in Economics and Finance 2006 183, Society for Computational Economics.
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Citations

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Cited by:
  1. Dennis, Richard, 2010. "How robustness can lower the cost of discretion," Journal of Monetary Economics, Elsevier, vol. 57(6), pages 653-667, September.
  2. Klaus Adam & Albert Marcet, 2011. "Internal Rationality, Imperfect Market Knowledge and Asset Prices," CEP Discussion Papers dp1068, Centre for Economic Performance, LSE.
  3. Evans, George & Honkapohja, Seppo, 2008. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," SIRE Discussion Papers 2008-03, Scottish Institute for Research in Economics (SIRE).
  4. Karantounias, Anastasios G., 2013. "Managing pessimistic expectations and fiscal policy," Theoretical Economics, Econometric Society, vol. 8(1), January.
  5. Richard Dennis, 2007. "Model uncertainty and monetary policy," Working Paper Series 2007-09, Federal Reserve Bank of San Francisco.
  6. Thomas M. Mertens & Tarek A. Hassan, 2010. "The Social Cost of Near-Rational Investment," 2010 Meeting Papers 370, Society for Economic Dynamics.
  7. Justin Svec, 2011. "Optimal Capital Taxation and Consumer Uncertainty," Working Papers 1108, College of the Holy Cross, Department of Economics.
  8. Demertzis, Maria & Hughes Hallett, Andrew, 2008. "Asymmetric information and rational expectations: When is it right to be "wrong"?," Journal of International Money and Finance, Elsevier, vol. 27(8), pages 1407-1419, December.
  9. Olalla, Myriam García & Gómez, Alejandro Ruiz, 2011. "Robust control and central banking behaviour," Economic Modelling, Elsevier, vol. 28(3), pages 1265-1278, May.

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