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Rule-of-Thumb Behaviour and Monetary Policy

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  • Jeffery D. Amato
  • Thomas Laubach

Abstract

We investigate the implications of rule-of-thumb behaviour on the part of consumers or price setters for optimal monetary policy and simple interest rate rules. The existence of such behaviour leads to endogenous persistence in output and inflation; changes the transmission of shocks to these variables; and alters the policymaker's welfare objective. Our main finding is that highly inertial policy is optimal regardless of what fraction of agents occasionally follow a rule of thumb. We also find that the interest rate rule that implements optimal policy in the purely optimising case, and a first-difference version of Taylor's (1993) rule, have desirable properties in all of the cases we consider. By contrast, the coefficients in other optimised simple rules tend to be extremely sensitive with respect to the fraction of rule-of-thumb behaviour and changes in other parameters of the model.

Suggested Citation

  • Jeffery D. Amato & Thomas Laubach, 2001. "Rule-of-Thumb Behaviour and Monetary Policy," Finance and Economics Discussion Series 2002-05, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2002-05
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    More about this item

    Keywords

    Rule of thumb; Optimal monetary policy; interest rate rules;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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