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Robustly optimal monetary policy in a microfounded New Keynesian model

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  • Adam, Klaus
  • Woodford, Michael

Abstract

We consider optimal monetary stabilization policy in a New Keynesian model with explicit microfoundations, 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 close enough to model-consistency. We show how to characterize robustly optimal policy without restricting consideration a priori to a particular parametric family of candidate policy rules. We show that robustly optimal policy can be implemented through commitment to a target criterion involving only the paths of inflation and a suitably defined output gap, but that a concern for robustness requires greater resistance to surprise increases in inflation than would be considered optimal if one could count on the private sector to have “rational expectations.”

Suggested Citation

  • Adam, Klaus & Woodford, Michael, 2012. "Robustly optimal monetary policy in a microfounded New Keynesian model," Journal of Monetary Economics, Elsevier, vol. 59(5), pages 468-487.
  • Handle: RePEc:eee:moneco:v:59:y:2012:i:5:p:468-487 DOI: 10.1016/j.jmoneco.2012.05.003
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    References listed on IDEAS

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    1. Pierpaolo Benigno & Michael Woodford, 2005. "Inflation Stabilization And Welfare: The Case Of A Distorted Steady State," Journal of the European Economic Association, MIT Press, pages 1185-1236.
    2. Adam, Klaus & Billi, Roberto M., 2006. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(7), pages 1877-1905, October.
    3. Michael Woodford, 2010. "Robustly Optimal Monetary Policy with Near-Rational Expectations," American Economic Review, American Economic Association, pages 274-303.
    4. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
    5. 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.
    6. Li-Lin Ku & Chien-Pai Han, 2008. "Robust testing procedures of process locations," Quality & Quantity: International Journal of Methodology, Springer, pages 579-595.
    7. Giannoni, Marc P. & Woodford, Michael, 2017. "Optimal target criteria for stabilization policy," Journal of Economic Theory, Elsevier, vol. 168(C), pages 55-106.
    8. Benigno, Pierpaolo & Paciello, Luigi, 2014. "Monetary policy, doubts and asset prices," Journal of Monetary Economics, Elsevier, pages 85-98.
    9. Hans, Erwin & Wullink, Gerhard & van Houdenhoven, Mark & Kazemier, Geert, 2008. "Robust surgery loading," European Journal of Operational Research, Elsevier, vol. 185(3), pages 1038-1050, March.
    10. Timothy Cogley & Riccardo Colacito & Lars Peter Hansen & Thomas J. Sargent, 2008. "Robustness and U.S. Monetary Policy Experimentation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1599-1623, December.
    11. Lars Peter Hansen & Thomas J. Sargent, 2008. "Time Inconsistency of Robust Control?," Chapters,in: Macroeconomics in the Small and the Large, chapter 7 Edward Elgar Publishing.
    12. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
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    Citations

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    Cited by:

    1. Benigno, Pierpaolo & Paciello, Luigi, 2014. "Monetary policy, doubts and asset prices," Journal of Monetary Economics, Elsevier, pages 85-98.
    2. Ma, Ching-to Albert & Mak, Henry Y., 2015. "Information disclosure and the equivalence of prospective payment and cost reimbursement," Journal of Economic Behavior & Organization, Elsevier, pages 439-452.
    3. Anmol Bhandari & Jaroslav Borovička & Paul Ho, 2016. "Identifying Ambiguity Shocks in Business Cycle Models Using Survey Data," NBER Working Papers 22225, National Bureau of Economic Research, Inc.
    4. repec:eee:eecrev:v:100:y:2017:i:c:p:293-317 is not listed on IDEAS
    5. Kwon, Hyosung & Miao, Jianjun, 2017. "Three types of robust Ramsey problems in a linear-quadratic framework," Journal of Economic Dynamics and Control, Elsevier, vol. 76(C), pages 211-231.
    6. repec:spr:jeicoo:v:12:y:2017:i:3:d:10.1007_s11403-016-0174-z is not listed on IDEAS
    7. Driscoll, John C. & Holden, Steinar, 2014. "Behavioral economics and macroeconomic models," Journal of Macroeconomics, Elsevier, pages 133-147.
    8. Driscoll, John C. & Holden, Steinar, 2014. "Behavioral economics and macroeconomic models," Journal of Macroeconomics, Elsevier, pages 133-147.
    9. Frank Hespeler & Marco M. Sorge, 2013. "Does Near-Rationality Matter in First-Order Approximate Solutions? A Perturbation Approach," CSEF Working Papers 339, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    10. Michael Woodford, 2013. "Macroeconomic Analysis Without the Rational Expectations Hypothesis," Annual Review of Economics, Annual Reviews, vol. 5(1), pages 303-346, May.

    More about this item

    Keywords

    Robust control; Near-rational expectations; Belief distortions; Target criterion;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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