Robust monetary policy with imperfect knowledge
By: Athanasios Orphanides, John C. Williams
Contributors: Williams, John C. (John Carroll); Federal Reserve Bank of San Francisco
Series: FRBSF working paper -- 2007-08; FRBSF working paper (Online) -- #2007-08.
Publisher: Federal Reserve Bank of San Francisco
Published: 2007
Place of publication: San Francisco]
Language: eng
Format: [electronic resource] /
Description: We examine the performance and robustness properties of monetary policy rules in an  estimated macroeconomic model in which the economy undergoes structural change and  where private agents and the central bank possess imperfect knowledge about the true  structure of the economy. Policymakers follow an interest rate rule aiming to maintain  price stability and to minimize fluctuations of unemployment around its natural rate but are  uncertain about the economy's natural rates of interest and unemployment and how private  agents form expectations. In particular, we consider two models of expectations formation:  rational expectations and learning. We show that in this environment the ability to stabilize  the real side of the economy is significantly reduced relative to an economy under rational  expectations with perfect knowledge. Furthermore, policies that would be optimal under  perfect knowledge can perform very poorly if knowledge is imperfect. Efficient policies that  take account of private learning and misperceptions of natural rates call for greater policy  inertia, a more aggressive response to inflation, and a smaller response to the perceived  unemployment gap than would be optimal if everyone had perfect knowledge of the economy.  We show that such policies are quite robust to potential misspecification of private sector  learning and the magnitude of variation in natural rates.
Notes: Title from PDF file (viewed on Sept. 13, 2007).

"March 2007."

Includes bibliographical references.

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