Working Paper: NBER ID: w11896
Authors: Michael Woodford
Abstract: The paper considers optimal monetary stabilization policy in a forward-looking model, 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 that are close enough to model-consistency. The proposed method offers a way of avoiding the assumption that the central bank can count on private-sector expectations coinciding precisely with whatever it plans to do, while at the same time also avoiding the equally unpalatable assumption that the central bank can precisely model private-sector learning and optimize in reliance upon a precise law of motion for expectations. \nThe main qualitative conclusions of the rational-expectations analysis of optimal policy carry over to the weaker assumption of near-rational expectations. It is found that commitment continues to be important for optimal policy, that the optimal long-run inflation target is unaffected by the degree of potential distortion of beliefs, and that optimal policy is even more history-dependent than if rational expectations are assumed.
Keywords: No keywords provided
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 |
|---|---|
| monetary policy commitment (E52) | private sector expectations (E69) |
| private sector expectations (E69) | economic outcomes (F61) |
| optimal monetary policy under NRE (E63) | commitment (D70) |
| policy commitment (E60) | inflation target (E31) |
| historical context (B15) | future policy effectiveness (D78) |
| systematic forecasting errors (C53) | public expectations (D84) |
| monetary policy (E52) | beneficial mistakes in public expectations (D84) |