Monetary Policy with Imperfect Knowledge

13 Pages Posted: 7 Dec 2005

See all articles by Athanasios Orphanides

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Asia School of Business

John C. Williams

Federal Reserve Bank of New York

Date Written: October 2005

Abstract

We examine the performance and robustness of monetary policy rules when the central bank and the public have imperfect knowledge of the economy and continuously update their estimates of model parameters. We find that versions of the Taylor rule calibrated to perform well under rational expectations with perfect knowledge perform very poorly when agents are learning and the central bank faces uncertainty regarding natural rates. In contrast, difference rules, in which the change in the interest rate is determined by the inflation rate and the change in the unemployment rate, perform well when knowledge is both perfect and imperfect.

Keywords: Natural rate of interest, natural rate of unemployment, rational expectations, learning, monetary policy rules, Taylor rule

JEL Classification: E52

Suggested Citation

Orphanides, Athanasios and Williams, John C., Monetary Policy with Imperfect Knowledge (October 2005). FEDS Working Paper No. 2005-51, Available at SSRN: https://ssrn.com/abstract=864404 or http://dx.doi.org/10.2139/ssrn.864404

Athanasios Orphanides (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=54058

Asia School of Business ( email )

Jalan Kuching, Kuala Lumpur, Wilayah Persekutuan K
Kuala Lumpur, MA
Malaysia

John C. Williams

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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