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Discretionary Policy, Potential Output Uncertainty, and Optimal Learning

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We compare inflation targeting, price level targeting, and speed limit policies when a central bank sets monetary policy under discretion, and must learn about the level of potential output over time. We show that if the central bank learns optimally over time, a speed limit policy dominates [is dominated by] a price level target if society places a high [low] weight on inflation stability. Inefficient learning on the part of the central bank can radically change this conclusion. A speed limit policy is favoured if the central bank places too much weight on recent data when estimating potential output, while a price level target is favoured if the central bank places too much weight on historical data.

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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2005/07.

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Date of creation: Dec 2005
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Handle: RePEc:nzb:nzbdps:2005/07

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  1. Currie,David & Levine,Paul, 1993. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521441964, April.
  2. Orphanides, Athanasios & Porter, Richard D. & Reifschneider, David & Tetlow, Robert & Finan, Frederico, 2000. "Errors in the measurement of the output gap and the design of monetary policy," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 117-141.
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  4. Yetman, James, 2006. "Are speed limit policies robust?," Journal of Macroeconomics, Elsevier, vol. 28(4), pages 665-679, December.
  5. Athanasios Orphanides & John C. Williams, 2002. "Robust monetary policy rules with unknown natural rates," Working Paper Series 2003-01, Federal Reserve Bank of San Francisco.
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  7. Jensen, Henrik, 1999. "Targeting Nominal Income Growth or Inflation?," CEPR Discussion Papers 2341, C.E.P.R. Discussion Papers.
  8. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
  9. Athanasios Orphanides & Simon van Norden, 1999. "The Reliability of Output Gap Estimates in Real Time," Macroeconomics 9907006, EconWPA.
  10. Wieland, Volker, 2000. "Monetary policy, parameter uncertainty and optimal learning," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 199-228, August.
  11. William Poole, 1998. "A policymaker confronts uncertainty," Speech 88, Federal Reserve Bank of St. Louis.
  12. Walsh, Carl E., 2004. "Implications of a Changing Economic Structure for the Strategy of Monetary Policy," Santa Cruz Center for International Economics, Working Paper Series qt84g1q1g6, Center for International Economics, UC Santa Cruz.
  13. Svensson, Lars E O, 1996. "Price-level Targeting versus Inflation Targeting: A Free Lunch?," CEPR Discussion Papers 1510, C.E.P.R. Discussion Papers.
  14. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
  15. Yetman, James, 2005. "The credibility of the monetary policy "free lunch"," Journal of Macroeconomics, Elsevier, vol. 27(3), pages 434-451, September.
  16. William Poole, 1998. "A policymaker confronts uncertainty," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 3-8.
  17. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
  18. Robert Dittmar & William T. Gavin, 2000. "What do New-Keynesian Phillips Curves imply for price-level targeting?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 21-30.
  19. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
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