IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Learning, Expectations Formation, And The Pitfalls Of Optimal Control Monetary Policy

  • Athanasios Orphanides

    ()

  • John C. Williams

    ()

This paper examines the robustness characteristics of optimal control policies derived un- der the assumption of rational expectations to alternative models of expectations. 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 find that the optimal control policy derived under the assumption of rational expectations can perform poorly when expectations deviate modestly from rational expectations. We then show that the optimal control policy can be made more robust by deemphasizing the stabilization of real economic activity and interest rates relative to infla- tion in the central bank loss function. That is, robustness to learning provides an incentive to employ a "conservative" central banker. We then examine two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts. We find that these policies are robust to empirically plausible parame- terizations of the learning models and perform about as well or better than optimal control policies.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://cbe.anu.edu.au/research/papers/camawpapers/Papers/2008/Orphanides_Williams_172008.pdf
Our checks indicate that this address may not be valid because: 404 Not Found. If this is indeed the case, please notify (Cama Admin)


Download Restriction: no

Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2008-17.

as
in new window

Length: 40 pages
Date of creation: Apr 2008
Date of revision:
Handle: RePEc:een:camaaa:2008-17
Contact details of provider: Postal: Crawford Building, Lennox Crossing, Building #132, Canberra ACT 2601
Phone: +61 2 6125 4705
Fax: +61 2 6125 5448
Web page: http://cama.crawford.anu.edu.au
Email:


More information through EDIRC

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.:

as in new window
  1. Athanasios Orphanides & John C. Williams, 2002. "Imperfect knowledge, inflation expectations, and monetary policy," Working Paper Series 2002-04, Federal Reserve Bank of San Francisco.
  2. N. Gregory Mankiw & Ricardo Reis & Justin Wolfers, 2003. "Disagreement about Inflation Expectations," Harvard Institute of Economic Research Working Papers 2011, Harvard - Institute of Economic Research.
  3. Branch, William A. & Evans, George W., 2006. "A simple recursive forecasting model," Economics Letters, Elsevier, vol. 91(2), pages 158-166, May.
  4. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 263-318 National Bureau of Economic Research, Inc.
  5. Timothy Cogley & Thomas J. Sargent, 2002. "Evolving Post-World War II U.S. Inflation Dynamics," NBER Chapters, in: NBER Macroeconomics Annual 2001, Volume 16, pages 331-388 National Bureau of Economic Research, Inc.
  6. Athanasios Orphanides & John C. Williams, 2006. "Inflation targeting under imperfect knowledge," Working Paper Series 2006-14, Federal Reserve Bank of San Francisco.
  7. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September.
  8. Athanasios Orphanides & John C. Williams, 2002. "Robust Monetary Policy Rules with Unknown Natural Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 63-146.
  9. John C. Williams & Andrew T. Levin, 2003. "Robust Monetary Policy with Competing Reference Models," Computing in Economics and Finance 2003 291, Society for Computational Economics.
  10. Dean Croushore, 1993. "Introducing: the survey of professional forecasters," Business Review, Federal Reserve Bank of Philadelphia, issue Nov, pages 3-15.
  11. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  12. Orphanides, Athanasios & Williams, John C., 2007. "Robust monetary policy with imperfect knowledge," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1406-1435, July.
  13. Lars O. Svensson & Robert J. Tetlow, 2005. "Optimal Policy Projections," NBER Working Papers 11392, National Bureau of Economic Research, Inc.
  14. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  15. Taylor, John B., 1998. "The Robustness and Efficiency of Monetary Policy Rules as Guidelines for Interest Rate Setting by the European Central Bank," Seminar Papers 649, Stockholm University, Institute for International Economic Studies.
  16. William A. Brock & Steven N. Durlauf & Kenneth D. West, 2004. "Model Uncertainty and Policy Evaluation: Some Theory and Empirics," NBER Working Papers 10916, National Bureau of Economic Research, Inc.
  17. Milani, Fabio, 2007. "Expectations, learning and macroeconomic persistence," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 2065-2082, October.
  18. Dean Croushore & Tom Stark, 1999. "A real-time data set for macroeconomists," Working Papers 99-4, Federal Reserve Bank of Philadelphia.
  19. Svensson, Lars E. O. & Williams, Noah, 2005. "Monetary policy with model uncertainty: distribution forecast targeting," Discussion Paper Series 1: Economic Studies 2005,35, Deutsche Bundesbank, Research Centre.
  20. 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.
  21. Gaspar, Vítor & Smets, Frank & Vestin, David, 2006. "Adaptive learning, persistence, and optimal monetary policy," Working Paper Series 0644, European Central Bank.
  22. Andrew Levin & Volker Wieland & John Williams, 2000. "The Performance Of Forecast-Based Monetary Policy Rules Under Model Uncertainty," Computing in Economics and Finance 2000 203, Society for Computational Economics.
  23. Robert E. Hall, 1984. "Monetary strategy with an elastic price standard," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 137-167.
  24. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  25. John C. Williams, 1999. "Simple rules for monetary policy," Finance and Economics Discussion Series 1999-12, Board of Governors of the Federal Reserve System (U.S.).
  26. Taylor, John B, 1975. "Monetary Policy during a Transition to Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 83(5), pages 1009-21, October.
  27. Kosuke Aoki & Kalin Nikolov, 2004. "Rule-based monetary policy under central bank learning," Bank of England working papers 235, Bank of England.
  28. Thomas J Sargent, 2007. "Evolution and Intelligent Design," Levine's Bibliography 122247000000001821, UCLA Department of Economics.
  29. Peter Isard & Douglas Laxton & Ann-Charlotte Eliasson, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," Computing in Economics and Finance 1999 841, Society for Computational Economics.
  30. Robert J. Tetlow, 2010. "Real-time model uncertainty in the United States: 'Robust' policies put to the test," Finance and Economics Discussion Series 2010-15, Board of Governors of the Federal Reserve System (U.S.).
  31. Lars E.O. Svensson, 2002. "Inflation Targeting: Should It Be Modeled as an Instrument Rule or a Targeting Rule?," NBER Working Papers 8925, National Bureau of Economic Research, Inc.
  32. Chow, Gregory C, 1976. "Control Methods for Macroeconomic Policy Analysis," American Economic Review, American Economic Association, vol. 66(2), pages 340-45, May.
  33. Schmidt-Hebbel, Klaus & Tapia, Matias, 2002. "Inflation targeting in Chile," The North American Journal of Economics and Finance, Elsevier, vol. 13(2), pages 125-146, August.
  34. 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.
  35. Ferrero, Giuseppe, 2007. "Monetary policy, learning and the speed of convergence," Journal of Economic Dynamics and Control, Elsevier, vol. 31(9), pages 3006-3041, September.
Full references (including those not matched with items on IDEAS)

This item is featured on the following reading lists or Wikipedia pages:

  1. Athanasios Orphanides in Wikipedia English ne '')

When requesting a correction, please mention this item's handle: RePEc:een:camaaa:2008-17. 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: (Cama Admin)

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 references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

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

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.