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Discretionary Policy, Potential Output Uncertainty, and Optimal Learning

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We compare inflation targeting, price level targeting, and speed limit policies when a central bank sets monetary policy under discretion, and must learn about the level of potential output over time. We show that if the central bank learns optimally over time, a speed limit policy dominates [is dominated by] a price level target if society places a high [low] weight on inflation stability. Inefficient learning on the part of the central bank can radically change this conclusion. A speed limit policy is favoured if the central bank places too much weight on recent data when estimating potential output, while a price level target is favoured if the central bank places too much weight on historical data.

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File URL: http://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/Discussion%20papers/2005/dp05-07.pdf
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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2005/07.

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Date of creation: Dec 2005
Handle: RePEc:nzb:nzbdps:2005/07
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  1. Athanasios Orphanides & John C. Williams, 2002. "Robust monetary policy rules with unknown natural rates," Working Paper Series 2003-01, Federal Reserve Bank of San Francisco.
  2. Volker W. Wieland, 1999. "Monetary policy, parameter uncertainty and optimal learning," Finance and Economics Discussion Series 1999-48, Board of Governors of the Federal Reserve System (U.S.).
  3. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
  4. Svensson, Lars E O, 1999. "Price-Level Targeting versus Inflation Targeting: A Free Lunch?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 277-295, August.
  5. Athanasios Orphanides & Simon van Norden, 1999. "The Reliability of Output Gap Estimates in Real Time," Macroeconomics 9907006, EconWPA.
  6. William Poole, 1998. "A policymaker confronts uncertainty," Speech 88, Federal Reserve Bank of St. Louis.
  7. Yetman, James, 2003. "The credibility of the monetary policy "free lunch"," Working Paper Series 0284, European Central Bank.
  8. Carl E. Walsh, 2003. "Implications of a changing economic structure for the strategy of monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 297-348.
  9. Orphanides, Athanasios, 2000. "The quest for prosperity without inflation," Working Paper Series 0015, European Central Bank.
  10. Glenn D. Rudebusch, 1999. "Is the Fed too timid? Monetary policy in an uncertain world," Working Papers in Applied Economic Theory 99-05, Federal Reserve Bank of San Francisco.
  11. Carl Walsh, 2003. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 93(1), pages 265-278, March.
  12. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
  13. Henrik Jensen, "undated". "Targeting Nominal Income Growth or Inflation?," EPRU Working Paper Series 99-23, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  14. Athanasios Orphanides & Richard D. Porter & David L. Reifschneider & Robert J. Tetlow & Frederico Finan, 1999. "Errors in the measurement of the output gap and the design of monetary policy," Finance and Economics Discussion Series 1999-45, Board of Governors of the Federal Reserve System (U.S.).
  15. Yetman, James, 2006. "Are speed limit policies robust?," Journal of Macroeconomics, Elsevier, vol. 28(4), pages 665-679, December.
  16. Robert Dittmar & William T. Gavin, 2000. "What do New-Keynesian Phillips Curves imply for price-level targeting?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 21-30.
  17. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
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