Learning, expectations formation, and the pitfalls of optimal control monetary policy

Athanasios Orphanides and John Williams

Journal of Monetary Economics, 2008, vol. 55, issue Supplement 1, S80-S96

Abstract: The optimal control approach to monetary policy has garnered increased attention in recent years. Optimal control policies, however, are designed for the specific features of a particular model and therefore may not be robust to model misspecification. One important source of potential misspecification is how agents form expectations. Specifically, whether they know the complete structure of the model as assumed in rational expectations or learn using a forecasting model that they update based on incoming data. Simulations of an estimated model of the U.S. economy show that the optimal control policy derived under the assumption of rational expectations can perform poorly when agents learn. The optimal control approach can be made more robust to learning by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to learning provides an incentive to employ a "conservative" central banker. In contrast to optimal control policies, two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts are shown to be robust to learning.

Keywords: Rational; expectations; Robust; control; Model; uncertainty (search for similar items in EconPapers)
Date: 2008
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (59)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0304-3932(08)00109-8
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Learning, Expectations Formation, and the Pitfalls of Optimal Control Monetary Policy (2008)
Working Paper: LEARNING, EXPECTATIONS FORMATION, AND THE PITFALLS OF OPTIMAL CONTROL MONETARY POLICY (2008)
Working Paper: Learning, expectations formation and the pitfalls of optimal control monetary policy (2008)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:55:y:2008:i:s1:p:s80-s96

Access Statistics for this article

Journal of Monetary Economics is currently edited by R. G. King and C. I. Plosser

More articles in Journal of Monetary Economics from Elsevier
Bibliographic data for series maintained by Catherine Liu ().