Optimal Monetary Policy Under Bounded Rationality

August 2, 2019

Preview Citation

Format: Chicago

Jonathan Benchimol, and Lahcen Bounader. Optimal Monetary Policy Under Bounded Rationality, (USA: International Monetary Fund, 2019) accessed December 23, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

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.

Subject: Banking, Inflation, Neoclassical theory, Output gap, Real interest rates

Keywords: Central bank, Monetary policy, WP

Publication Details

Pages:

52
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2019/166
Stock No:

WPIEA2019166
ISBN:

9781498324588
ISSN:

1018-5941

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