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Optimal Monetary Policy Under Bounded Rationality

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Listed:
  • Jonathan Benchimol
  • Lahcen Bounader

Abstract

The form of bounded rationality characterizing the representative agent is key in the choice of the optimal monetary policy regime. While inflation targeting prevails for myopia that distorts agents' inflation expectations, price level targeting emerges as the optimal policy under myopia regarding the output gap, revenue, or interest rate. To the extent that bygones are not bygones under price level targeting, rational inflation expectations is a minimal condition for optimality in a behavioral world. Instrument rules implementation of this optimal policy is shown to be infeasible, questioning the ability of simple rules à la Taylor (1993) to assist the conduct of monetary policy. Bounded rationality is not necessarily associated with welfare losses.

Suggested Citation

  • Jonathan Benchimol & Lahcen Bounader, 2019. "Optimal Monetary Policy Under Bounded Rationality," IMF Working Papers 19/166, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:19/166
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Bank rates; Financial crises; Monetary policy; Central bank policy; Central banks; myopia; commitment; discretion; optimal simple rules.; output gap; PLT; cost-push; optimal monetary policy;

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory

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