IDEAS home Printed from https://ideas.repec.org/h/nbr/nberch/0082.html
   My bibliography  Save this book chapter

Rule-Based Monetary Policy under Central Bank Learning

In: NBER International Seminar on Macroeconomics 2004

Author

Listed:
  • Kosuke Aoki
  • Kalin Nikolov

Abstract

This paper evaluates the performance of three popular monetary policy rules where the central bank is learning about the parameter values of a simple New Keynesian model. The three policies are: (1) the optimal non-inertial rule; (2) the optimal history-dependent rule; (3) the optimal price level targeting rule. Under rational expectations rules (2) and (3) both implement the fully optimal equilibrium by improving the output/inflation trade-off. When imperfect information about the model parameters is introduced, the central bank makes monetary policy mistakes, which affect welfare to a different degree under the three rules. The optimal history-dependent rule is worst affected and delivers the lowest welfare. Price level targeting performs best under learning and maintains the advantages of conducting policy under commitment. These findings are related to the literature on feedback control and robustness. The paper argues that adopting integral representations of rules designed under full information is desirable, because these rules deliver the beneficial output/inflation trade-off of commitment policy, while being robust to implementation errors.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Kosuke Aoki & Kalin Nikolov, 2006. "Rule-Based Monetary Policy under Central Bank Learning," NBER Chapters, in: NBER International Seminar on Macroeconomics 2004, pages 145-195, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberch:0082
    as

    Download full text from publisher

    File URL: http://www.nber.org/chapters/c0082.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
    2. Fuhrer, Jeffrey C, 1997. "The (Un)Importance of Forward-Looking Behavior in Price Specifications," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 338-350, August.
    3. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
    4. Lars E.O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters, in: The Inflation-Targeting Debate, pages 19-92, National Bureau of Economic Research, Inc.
    5. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
    6. Svensson, Lars E. O., 2002. "Inflation targeting: Should it be modeled as an instrument rule or a targeting rule?," European Economic Review, Elsevier, vol. 46(4-5), pages 771-780, May.
    7. repec:cup:macdyn:v:6:y:2002:i:1:p:111-44 is not listed on IDEAS
    8. 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.
    9. Bennett T. McCallum & Edward Nelson, 1999. "Performance of Operational Policy Rules in an Estimated Semiclassical Structural Model," NBER Chapters, in: Monetary Policy Rules, pages 15-56, National Bureau of Economic Research, Inc.
    10. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: II. Applications," NBER Working Papers 9420, National Bureau of Economic Research, Inc.
    11. In-Koo Cho & Noah Williams & Thomas J. Sargent, 2002. "Escaping Nash Inflation," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 1-40.
    12. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    13. William Poole & Robert H. Rasche, 2002. "Flation," Review, Federal Reserve Bank of St. Louis, vol. 84(Nov), pages 1-6.
      • William Poole, 2002. "Flation," Speech 49, Federal Reserve Bank of St. Louis.
    14. Athanasios Orphanides & John Williams, 2004. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Chapters, in: The Inflation-Targeting Debate, pages 201-246, National Bureau of Economic Research, Inc.
    15. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(s1), pages 1-35.
    16. Bruce Preston, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
    17. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
    18. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-684, November.
    19. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
    20. Giannoni, Marc P., 2002. "Does Model Uncertainty Justify Caution? Robust Optimal Monetary Policy In A Forward-Looking Model," Macroeconomic Dynamics, Cambridge University Press, vol. 6(1), pages 111-144, February.
    21. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    22. William Kerr & Robert G. King, 1996. "Limits on interest rate rules in the IS model," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 47-75.
    23. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 277-316.
    24. Michael Woodford, 1998. "Control of the Public Debt: A Requirement for Price Stability?," International Economic Association Series, in: Guillermo Calvo & Mervyn King (ed.), The Debt Burden and its Consequences for Monetary Policy, chapter 5, pages 117-158, Palgrave Macmillan.
    25. Aoki, Kosuke, 2006. "Optimal commitment policy under noisy information," Journal of Economic Dynamics and Control, Elsevier, vol. 30(1), pages 81-109, January.
    26. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361, National Bureau of Economic Research, Inc.
    27. 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.
    28. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
    29. Levine, Paul & Currie, David, 1987. "The design of feedback rules in linear stochastic rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 11(1), pages 1-28, March.
    30. Marc P. Giannoni, 2010. "Optimal Interest-Rate Rules in a Forward-Looking Model, and Inflation Stabilization versus Price-Level Stabilization," NBER Working Papers 15986, National Bureau of Economic Research, Inc.
    31. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608.
    32. Seppo Honkapohja & Kaushik Mitra & George W. Evans, 2011. "Notes on Agents¡¯ Behavioral Rules Under Adaptive Learning and Studies of Monetary Policy," CDMA Working Paper Series 201102, Centre for Dynamic Macroeconomic Analysis.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Rochelle M. Edge & Thomas Laubach & John C. Williams, 2010. "Welfare-maximizing monetary policy under parameter uncertainty," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(1), pages 129-143.
    2. Orphanides, Athanasios & Williams, John C., 2008. "Learning, expectations formation, and the pitfalls of optimal control monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(Supplemen), pages 80-96, October.
    3. Michael Woodford, 2008. "How Important Is Money in the Conduct of Monetary Policy?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1561-1598, December.
    4. Aoki, Kosuke, 2006. "Optimal commitment policy under noisy information," Journal of Economic Dynamics and Control, Elsevier, vol. 30(1), pages 81-109, January.
    5. Woodford, Michael, 2013. "Forward Guidance by Inflation-Targeting Central Banks," CEPR Discussion Papers 9722, C.E.P.R. Discussion Papers.
    6. Giuseppe Ferrero, 2004. "Monetary Policy and the Transition to Rational Expectations," Econometric Society 2004 North American Summer Meetings 101, Econometric Society.
    7. Railavo, Jukka, 2006. "Essays on macroeconomic effects of fiscal policy rules," Scientific Monographs, Bank of Finland, number 2006_033.
    8. Eric Schaling & James Bullard, 2005. "Monetary Policy, Determinacy, and Learnability in the Open Economy," Computing in Economics and Finance 2005 362, Society for Computational Economics.
    9. Mr. Rafael A Portillo & Ms. Filiz D Unsal & Mr. Andrew Berg, 2010. "On the Optimal Adherence to Money Targets in a New-Keynesian Framework: An Application to Low-Income Countries," IMF Working Papers 2010/134, International Monetary Fund.
    10. Dennis, Richard & Ravenna, Federico, 2008. "Learning and optimal monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(6), pages 1964-1994, June.
    11. Dib, Ali & Mendicino, Caterina & Zhang, Yahong, 2013. "Price-level targeting rules and financial shocks: The case of Canada," Economic Modelling, Elsevier, vol. 30(C), pages 941-953.
    12. Woodford, Michael, 2010. "Optimal Monetary Stabilization Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 14, pages 723-828, Elsevier.
    13. Yu-chin Chen & Pisut Kulthanavit, 2008. "Adaptive Learning and Monetary Policy: Lessons from Japan," Working Papers UWEC-2008-12-P, University of Washington, Department of Economics, revised Oct 2008.
    14. Michael Woodford, 2007. "The Case for Forecast Targeting as a Monetary Policy Strategy," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 3-24, Fall.
    15. Loisel, Olivier, 2008. "Central bank reputation in a forward-looking model," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3718-3742, November.
    16. Mele, Antonio & Molnár, Krisztina & Santoro, Sergio, 2020. "On the perils of stabilizing prices when agents are learning," Journal of Monetary Economics, Elsevier, vol. 115(C), pages 339-353.
    17. Marest, Luc & Thurston, Thom, 2018. "Measuring the value of central bank commitment in the benchmark New Keynesian model," Journal of Macroeconomics, Elsevier, vol. 58(C), pages 249-265.
    18. Federico Ravenna, 2014. "How Central Banks Learn the True Model of the Economy," Cahiers de recherche 1409, CIRPEE.
    19. Alberto Locarno & Alessandra Locarno, 2021. "Is inflation targeting a strategy past its sell-by date?," Temi di discussione (Economic working papers) 1316, Bank of Italy, Economic Research and International Relations Area.
    20. Jukka Railavo, 2005. "Monetary Concequences of Alternative Fiscal Policy Rules," Computing in Economics and Finance 2005 145, Society for Computational Economics.
    21. Walsh, Carl E., 2005. "Endogenous objectives and the evaluation of targeting rules for monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(5), pages 889-911, July.
    22. Minford, Patrick & Nowell, Eric & Webb, Bruce, 2005. "Would price-level targeting destabilise the economy?," Cardiff Economics Working Papers E2005/12, Cardiff University, Cardiff Business School, Economics Section.
    23. Railavo, Jukka, 2004. "Monetary consequences of alternative fiscal policy rules," Research Discussion Papers 20/2004, Bank of Finland.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Aoki, Kosuke & Nikolov, Kalin, 2005. "Rule-Based Monetary Policy Under Central Banking Learning," CEPR Discussion Papers 5056, C.E.P.R. Discussion Papers.
    2. Lars E.O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters, in: The Inflation-Targeting Debate, pages 19-92, National Bureau of Economic Research, Inc.
    3. Marc Giannoni & Michael Woodford, 2004. "Optimal Inflation-Targeting Rules," NBER Chapters, in: The Inflation-Targeting Debate, pages 93-172, National Bureau of Economic Research, Inc.
    4. Aoki, Kosuke, 2006. "Optimal commitment policy under noisy information," Journal of Economic Dynamics and Control, Elsevier, vol. 30(1), pages 81-109, January.
    5. Galí, Jordi, 2002. "New Perspectives on Monetary Policy, Inflation and the Business Cycle," CEPR Discussion Papers 3210, C.E.P.R. Discussion Papers.
    6. George W. Evans & Seppo Honkapohja, 2003. "Adaptive learning and monetary policy design," Proceedings, Federal Reserve Bank of Cleveland, pages 1045-1084.
    7. Henrik Jensen, 2002. "Targeting Nominal Income Growth or Inflation?," American Economic Review, American Economic Association, vol. 92(4), pages 928-956, September.
    8. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    9. A. Hakan Kara, 2002. "Robust Targeting Rules for Monetary Policy," Discussion Papers 0208, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    10. George W. Evans & Seppo Honkapohja, 2006. "Monetary Policy, Expectations and Commitment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 108(1), pages 15-38, March.
    11. George W. Evans & Seppo Honkapohja, 2009. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," Central Banking, Analysis, and Economic Policies Book Series, in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 2, pages 027-076, Central Bank of Chile.
    12. Nicoletta Batini & Joseph Pearlman, 2002. "Too Much Too Soon: Instability and Indeterminacy with Forward-Looking Rules," Discussion Papers 08, Monetary Policy Committee Unit, Bank of England.
    13. Bennett T. McCallum & Edward Nelson, 2004. "Timeless perspective vs. discretionary monetary policy in forward-looking models," Review, Federal Reserve Bank of St. Louis, vol. 86(Mar), pages 43-56.
    14. Nessen, Marianne & Vestin, David, 2005. "Average Inflation Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 837-863, October.
    15. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
    16. Levin, Andrew T. & Williams, John C., 2003. "Robust monetary policy with competing reference models," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 945-975, July.
    17. Dennis, Richard & Soderstrom, Ulf, 2006. "How Important Is Precommitment for Monetary Policy?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(4), pages 847-872, June.
    18. Bennett T. McCallum & Edward Nelson, 2005. "Targeting versus instrument rules for monetary policy," Review, Federal Reserve Bank of St. Louis, vol. 87(Sep), pages 597-612.
    19. Kimura, Takeshi & Kurozumi, Takushi, 2007. "Optimal monetary policy in a micro-founded model with parameter uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 31(2), pages 399-431, February.
    20. Benigno, Gianluca & Benigno, Pierpaolo, 2002. "Implementing Monetary Cooperation Through Inflation Targeting," CEPR Discussion Papers 3226, C.E.P.R. Discussion Papers.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberch:0082. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://edirc.repec.org/data/nberrus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (email available below). General contact details of provider: https://edirc.repec.org/data/nberrus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.