Rule-of-Thumb Behaviour and Monetary Policy

51 Pages Posted: 3 Feb 2002

See all articles by Thomas Laubach

Thomas Laubach

Federal Reserve Board

Jeffery D. Amato

Goldman Sachs International

Date Written: January 2002

Abstract

We investigate the implications of rule-of-thumb behaviour on the part of consumers or price setters for optimal monetary policy and simple interest rate rules. The existence of such behaviour leads to endogenous persistence in output and inflation; changes the transmission of shocks to these variables; and alters the policymaker's welfare objective. Our main finding is that highly inertial policy is optimal regardless of what fraction of agents occasionally follow a rule of thumb. We also find that the interest rate rule that implements optimal policy in the purely optimising case, and a first-difference version of Taylor's (1993) rule, have desirable properties in all of the cases we consider. By contrast, the coefficients in other optimised simple rules tend to be extremely sensitive with respect to the fraction of rule-of-thumb behaviour and changes in other parameters of the model.

Keywords: Rule of thumb, optimal monetary policy, interest rate rules

JEL Classification: E31, E32, E52

Suggested Citation

Laubach, Thomas and Amato, Jeffery D., Rule-of-Thumb Behaviour and Monetary Policy (January 2002). FEDS Working Paper No. 2002-05. Available at SSRN: https://ssrn.com/abstract=299246 or http://dx.doi.org/10.2139/ssrn.299246

Thomas Laubach (Contact Author)

Federal Reserve Board ( email )

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Washington, DC 20551
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202-452-2715 (Phone)
202-452-3819 (Fax)

Jeffery D. Amato

Goldman Sachs International ( email )

United States

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