Robustly Optimal Monetary Policy with Near Rational Expectations

Michael Woodford

No 11896, NBER Working Papers from National Bureau of Economic Research, Inc

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. The 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.

JEL-codes: D81 D84 E52 (search for similar items in EconPapers)
Date: 2005-12
New Economics Papers: this item is included in nep-cba, nep-knm, nep-mac and nep-mon
Note: EFG ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

Published as Woodford, Michael. “An Example of Robustly Optimal Monetary Policy with Near-Rational Expectations.” Journal of the European Economics Association 4, 2-3 (2006): 386-395.
Published as Michael Woodford, 2010. "Robustly Optimal Monetary Policy with Near-Rational Expectations," American Economic Review, American Economic Association, vol. 100(1), pages 274-303, March.

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