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Title: Rule-Based Monetary Policy Under Central Banking Learning

Author(s): Kosuke Aoki and Kalin Nikolov

Publication Date: May 2005

Keyword(s): learning and monetary policy rules

Programme Area(s): International Macroeconomics

Abstract: The paper evaluates the performance of three popular monetary policy rules when the central bank is learning about the parameter values of a simple New Keynesian model. The three policies are: (1) the optimal non-inertial rule; (2) the optimal history-dependent rule; (3) the optimal price-level targeting rule. Under rational expectations rules (2) and (3) both implement the fully optimal equilibrium by improving the output-inflation trade off. When imperfect information about the model parameters is introduced, it is found that the central bank makes monetary policy mistakes, which affect welfare to a different degree under the three rules. The optimal history-dependent rule is worst affected and delivers the lowest welfare. Price level targeting performs best under learning and maintains the advantages of conducting policy under commitment. These findings are related to the literatures on feedback control and robustness. The paper argues that adopting integral representations of rules designed under full information is desirable because they deliver the beneficial output-inflation trade-off of commitment policy while being robust to implementation errors.

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Bibliographic Reference

Aoki, K and Nikolov, K. 2005. 'Rule-Based Monetary Policy Under Central Banking Learning'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=5056