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Imperfect Knowledge And The Pitfalls Of Optimal Control Monetary Policy

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  • Athanasios Orphanides
  • John C. Williams

Abstract

This paper examines the robustness characteristics of optimal control policies derived under the assumption of rational expectations to alternative models of expectations formation and uncertainty about the natural rates of interest and unemployment. We assume that agents have imperfect knowledge about the precise structure of the economy and form expectations using a forecasting model that they continuously update based on incoming data. We also allow for central bank uncertainty regarding the natural rates of interest and unemployment. We find that the optimal control policy derived under the assumption of rational expectations performs rather poorly when agents learn. These problems are exacerbated by natural rate uncertainty, even

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 499.

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Date of creation: Oct 2008
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Handle: RePEc:chb:bcchwp:499

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  1. Alex Cukierman & Francesco Lippi, 2003. "Endogenous Monetary Policy with Unobserved Potential Output," CEIS Research Paper 26, Tor Vergata University, CEIS.
  2. Athanasios Orphanides & John C. Williams, 2003. "Robust monetary policy rules with unknown natural rates," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2003-11, Board of Governors of the Federal Reserve System (U.S.).
  3. John C. Williams, 1999. "Simple rules for monetary policy," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1999-12, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Athanasios Orphanides & John C. Williams, 2010. "Monetary Policy Mistakes and the Evolution of Inflation Expectations," Working Papers, Central Bank of Cyprus 2010-2, Central Bank of Cyprus.

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