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Monetary Policy with Imperfect Knowledge

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  • Athanasios Orphanides amd John Williams

Abstract

This paper studies the formulation of monetary policy in a changing environment when knowledge regarding some aspects of the structure of the economy is imperfect and an adaptive learning technology is available to the policymaker and economic agents. As a benchmark, we develop a simple model of the economy and identify efficient monetary policy rules under the assumptions that knowledge of the economy is perfect and expectations are formed rationally. We then relax the assumption of rational expectations and examine the design of policy when agents and/or the policymaker must rely on adaptive learning to form expectations. We show that policies that are efficient under rational expectations are no longer efficient under imperfect knowledge, and, conversely, that efficient policies under imperfect knowledge would appear inefficient to the outside observer who assumed perfect knowledge. Using these results, we discuss the role of imperfect knowledge on the evolution of monetary policy in the United States over the past twenty years.

Suggested Citation

  • Athanasios Orphanides amd John Williams, 2001. "Monetary Policy with Imperfect Knowledge," Computing in Economics and Finance 2001 254, Society for Computational Economics.
  • Handle: RePEc:sce:scecf1:254
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    References listed on IDEAS

    as
    1. Athanasios Orphanides & John C. Williams, 2007. "Inflation targeting under imperfect knowledge," Economic Review, Federal Reserve Bank of San Francisco, pages 1-23.
    2. Orphanides, Athanasios & Williams, John C., 2005. "The decline of activist stabilization policy: Natural rate misperceptions, learning, and expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1927-1950, November.
    3. John C. Williams, 2006. "Robust estimation and monetary policy with unobserved structural change," Economic Review, Federal Reserve Bank of San Francisco, pages 1-16.
    4. Athanasios Orphanides & John C. Williams, 2005. "Inflation scares and forecast-based monetary policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 498-527, April.
    5. 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.
    6. 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.
    7. 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.
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    More about this item

    Keywords

    monetary policy; learning; rational expectations; optimal control; nflation targeting; policy rules; expectation formation;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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