IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Monetary Policy Design under Imperfect Knowledge: An Open Economy Analysis

  • Yu-chin Chen

    (University of Washington)

  • Pisut Kulthanavit

    (University of Washington)

This paper incorporates adaptive learning into a standard New-Keynesian open economy dynamic stochastic general equilibrium (DSGE) model and analyze under what conditions policymakers should target domestic producer price inflation (DI) versus consumer price inflation (CI). Our goal is to examine how monetary policy rules should adjust when agents’ information sets deviate from those assumed under the rational expectation paradigm. When agents form expectations using an adaptive learning mechanism, even though the central bank has no informational advantage, monetary policy can nonetheless facilitate the learning process and thus mitigate distortions associated with imperfect knowledge. We assume the policy-maker follows a forwardlooking Taylor rule and focus on analyzing the interplay between the source of the dominant shock and the extent of knowledge imperfection. We find that when agents have very limited knowledge and have to learn the dynamics governing both the relevant economic indicators and the underlying structural shocks, a DI targeting rule introduces fewer forecast errors and is better at stabilizing the economy. However, when agents can observe contemporaneous shocks and need only learn how key economic variables evolve (a situation akin to a post-structural-shift economy), targeting away from the dominant shocks helps anchor expectations and improve welfare. A CI target can then become the preferred policy rule when the economy is subject to large domestic shocks.

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://faculty.washington.edu/yuchin/Papers/CK2.pdf
Download Restriction: no

Paper provided by University of Washington, Department of Economics in its series Working Papers with number UWEC-2008-14.

as
in new window

Length:
Date of creation: May 2008
Handle: RePEc:udb:wpaper:uwec-2008-14
Contact details of provider: Postal:
Box 353330, Seattle, WA 98193-3330

Web page: http://www.econ.washington.edu/
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. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  2. Lars E. O. Svensson, 2000. "Open-Economy Inflation Targeting," NBER Working Papers 6545, National Bureau of Economic Research, Inc.
  3. Maurice Obstfeld and Kenneth Rogoff., 2001. "Global Implications of Self-Oriented National Monetary Rules," Center for International and Development Economics Research (CIDER) Working Papers C01-120, University of California at Berkeley.
  4. Richard Clarida & Jordi Gali & Mark Gertler, 2002. "A Simple Framework for International Monetary Policy Analysis," NBER Working Papers 8870, National Bureau of Economic Research, Inc.
  5. Benigno, Pierpaolo, 2004. "Optimal monetary policy in a currency area," Journal of International Economics, Elsevier, vol. 63(2), pages 293-320, July.
  6. N. Gregory Mankiw & Ricardo Reis, 2002. "What Measure of Inflation Should a Central Bank Target?," Harvard Institute of Economic Research Working Papers 1984, Harvard - Institute of Economic Research.
  7. Jordi Galí & Mark Gertler, 2007. "Macroeconomic modeling for monetary policy evaluation," Economics Working Papers 1039, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2007.
  8. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  9. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
  10. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers 2005-11, University of Oregon Economics Department, revised 06 Apr 2005.
  11. Athanasios Orphanides & John C. Williams, 2003. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Working Papers 9884, National Bureau of Economic Research, Inc.
  12. A. Campolmi, 2005. "Which inflation to target? A small open economy with sticky wages indexed to past inflation," Working Papers 553, Dipartimento Scienze Economiche, Universita' di Bologna.
  13. Vicente Tuesta & Gonzalo Llosa, 2006. "Determinacy and Learnability of Monetary Policy Rules in Small Open Economies," IDB Publications (Working Papers) 6838, Inter-American Development Bank.
  14. Milani, Fabio, 2007. "Expectations, learning and macroeconomic persistence," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 2065-2082, October.
  15. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," FRB Atlanta Working Paper 2003-18, Federal Reserve Bank of Atlanta.
  16. Warwick J. McKibbin & Kang Yong Tan, 2006. "Learning And International Transmission Shocks," CAMA Working Papers 2007-01, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  17. Giancarlo Corsetti & Paolo Pesenti, 1997. "Welfare and Macroeconomic Interdependence," NBER Working Papers 6307, National Bureau of Economic Research, Inc.
  18. Bennett T. McCallum, 1998. "Solutions to Linear Rational Expectations Models: A Compact Exposition," NBER Technical Working Papers 0232, National Bureau of Economic Research, Inc.
  19. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Open versus Closed Economies: An Integrated Approach," American Economic Review, American Economic Association, vol. 91(2), pages 248-252, May.
  20. 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.
  21. McCallum, Bennett T., 1983. "On non-uniqueness in rational expectations models : An attempt at perspective," Journal of Monetary Economics, Elsevier, vol. 11(2), pages 139-168.
  22. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  23. Waters, George A., 2009. "Learning, Commitment, And Monetary Policy," Macroeconomic Dynamics, Cambridge University Press, vol. 13(04), pages 421-449, September.
  24. James B. Bullard & Eric Schaling, 2006. "Monetary policy, determinacy, and learnability in a two-block world economy," Working Papers 2006-038, Federal Reserve Bank of St. Louis.
  25. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:udb:wpaper:uwec-2008-14. 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: (Michael Goldblatt)

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.