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Optimal Monetary Policy Under Bounded Rationality

Jonathan Benchimol () and Lahcen Bounader

No 19/166, IMF Working Papers from International Monetary Fund

Abstract: The form of bounded rationality characterizing the representative agent is key in the choice of the optimal monetary policy regime. While inflation targeting prevails for myopia that distorts agents' inflation expectations, price level targeting emerges as the optimal policy under myopia regarding the output gap, revenue, or interest rate. To the extent that bygones are not bygones under price level targeting, rational inflation expectations is a minimal condition for optimality in a behavioral world. Instrument rules implementation of this optimal policy is shown to be infeasible, questioning the ability of simple rules à la Taylor (1993) to assist the conduct of monetary policy. Bounded rationality is not necessarily associated with welfare losses.

Date: 2019-08-02
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Working Paper: Optimal monetary policy under bounded rationality (2018) Downloads
Working Paper: Optimal Monetary Policy Under Bounded Rationality (2018) Downloads
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