Working Paper: CEPR ID: DP8826
Authors: Klaus Adam; Michael Woodford
Abstract: We consider optimal monetary stabilization policy in a New Keynesian model with explicit microfoundations, when the central bank recognizes that private-sector expectations need not be precisely model-consistent, and wishes to choose a policy that will be as good as possible in the case of any beliefs close enough to model-consistency. We show how to characterize robustly optimal policy without restricting consideration a priori to a particular parametric family of candidate policy rules. We show that robustly optimal policy can be implemented through commitment to a target criterion involving only the paths of inflation and a suitably defined output gap, but that a concern for robustness requires greater resistance to surprise increases in inflation than would be considered optimal if one could count on the private sector to have 'rational expectations'.
Keywords: belief distortions; near-rational expectations; robust control; target criterion
JEL Codes: D81; D84; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| robustly optimal monetary policy (E63) | inflation expectations (E31) |
| robustly optimal monetary policy (E63) | economic outcomes (F61) |
| policy commitments (E61) | inflation expectations (E31) |
| policy commitments (E61) | economic outcomes (F61) |
| belief distortions (G41) | economic outcomes (F61) |
| belief distortions (G41) | inflation expectations (E31) |