Optimal Monetary Policy Under Bounded Rationality

Jonathan Benchimol and Lahcen Bounader

No 67, Dynare Working Papers from CEPREMAP

Abstract: We build a behavioral New Keynesian model that emphasizes different forms of myopia for households and firms. By examining the optimal monetary policy within this model, we find four main results. First, in a framework where myopia distorts agents’ inflation expectations, the optimal monetary policy entails implementing inflation targeting. Second, price level targeting emerges as the optimal policy under output gap, revenue, or interest rate myopia. Given that bygones are not bygones under price level targeting, rational inflation expectations are a minimal condition for optimality in a behavioral world. Third, we show that there are no feasible instrument rules for implementing the optimal monetary policy, casting doubt on the ability of simple Taylor rules to assist in the setting of monetary policy. Fourth, bounded rationality may be associated with welfare gains.

Keywords: Behavioral macroeconomics; Central bank policy; Cognitive discounting; Heterogeneous expectations; Optimal simple rules (search for similar items in EconPapers)
JEL-codes: C53 D01 D11 E37 E52 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2021-03
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Optimal monetary policy under bounded rationality (2023)
Working Paper: Optimal monetary policy under bounded rationality (2023)
Working Paper: Optimal Monetary Policy under Bounded Rationality (2019)
Working Paper: Optimal Monetary Policy Under Bounded Rationality (2019)
Working Paper: Optimal Monetary Policy Under Bounded Rationality (2018)
Working Paper: Optimal monetary policy under bounded rationality (2018)
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