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Monetary policy with imperfect knowledge

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Author Info
Athanasios Orphanides
John C. Williams

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Abstract

We examine the performance and robustness of monetary policy rules when the central bank and the public have imperfect knowledge of the economy and continuously update their estimates of model parameters. We find that versions of the Taylor rule calibrated to perform well under rational expectations with perfect knowledge perform very poorly when agents are learning and the central bank faces uncertainty regarding natural rates. In contrast, difference rules, in which the change in the interest rate is determined by the inflation rate and the change in the unemployment rate, perform well when knowledge is both perfect and imperfect.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2005-51.

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Date of creation: 2005
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Handle: RePEc:fip:fedgfe:2005-51

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Keywords: Monetary policy Interest rates

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 173-203, January. [Downloadable!] (restricted)
  2. Orphanides, Athanasios & Williams, John C, 2006. "Inflation Targeting under Imperfect Knowledge," CEPR Discussion Papers 5664, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  3. Athanasios Orphanides & John C. Williams, 2003. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Working Papers 9884, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Athanasios Orphanides & John C. Williams, 2002. "Robust monetary policy rules with unknown natural rates," Working Papers in Applied Economic Theory 2003-01, Federal Reserve Bank of San Francisco. [Downloadable!]
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  5. Orphanides, Athanasios & Williams, John C., 2005. "The decline of activist stabilization policy: Natural rate misperceptions, learning, and expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1927-1950, November. [Downloadable!] (restricted)
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  6. John C. Williams, 2005. "Robust estimation and monetary policy with unobserved structural change," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 53-81. [Downloadable!]
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  7. Athanasios Orphanides & John C. Williams, 2003. "Inflation scares and forecast-based monetary policy," Working Paper 2003-21, Federal Reserve Bank of Atlanta. [Downloadable!]
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Athanasios Orphanides & John C. Williams, 2006. "Inflation targeting under imperfect knowledge," Finance and Economics Discussion Series 2006-20, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  2. George W. Evans & Bruce McGough, 2005. "Optimal Constrained Interest-rate Rules," University of Oregon Economics Department Working Papers 2005-9, University of Oregon Economics Department, revised 31 May 2006. [Downloadable!]
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  3. Mandler, Martin, 2006. "Are there gains from including monetary aggregates and stock market indices in the monetary policy reaction function? A simulation study of recent U.S. monetary policy," MPRA Paper 2318, University Library of Munich, Germany. [Downloadable!]
  4. Vitor Gaspar & Frank Smets & David Vestin, 2006. "Adaptive learning, persistence, and optimal monetary policy," Working Paper Series 644, European Central Bank. [Downloadable!]
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  5. Rochelle M. Edge & Thomas Laubach & John C. Williams, 2007. "Welfare-maximizing monetary policy under parameter uncertainty," Finance and Economics Discussion Series 2007-56, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  6. John C. Williams, 2006. "Monetary policy in a low inflation economy with learning," Working Paper Series 2006-30, Federal Reserve Bank of San Francisco. [Downloadable!]
  7. Keiko Honjo & Ben Hunt, 2006. "Stabilizing Inflation in Iceland," IMF Working Papers 06/262, International Monetary Fund. [Downloadable!]
  8. Alan S. Blinder & Ricardo Reis, 2005. "Understanding the Greenspan standard," Proceedings, Federal Reserve Bank of Kansas City, issue Aug, pages 11-96. [Downloadable!]
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