The paper reviews the recent literature on monetary policy rules. We exposit the monetary policy design problem within a simple baseline theoretical framework. We then consider the implications of adding various real world complications. Among other things, we show that the optimal policy implicitly incorporates inflation targeting. We also characterize the gains from making a credible commitment to fight inflation. In contrast to conventional wisdom, we show that gains from commitment may emerge even if the central bank is not trying to inadvisedly push output above its natural level. We also consider the implications of frictions such as imperfect information.

/pdf/the-science-of-monetary-policy-a-new-keynesian-perspective-1hk1n82x2a.pdf

The Science of Monetary Policy: A New Keynesian Perspective

https://pages.stern.nyu.edu/~dbackus/Exotic/1Robustness/Sims%20inattention%20JME%2003.pdf

Implications of rational inattention

It comes as something ofa surprise to reflect that the New York Review ofBooks is now over twenty years old. Even people of my generation (that is, old enough to remember the revolutionary 196os but not young enough to have taken a very exciting part in them) think of the paper as eternally youthful. In fact, it has gone through years of relatively quiet life, yet, as always in a competitive journalistic market, it is the controversies that attract the interest of the reader and to which the history (especially an admittedly impressionistic survey that tries to include something of the intellectual context in which a journal has operated) must give some attention. Not all the attacks which the New York Review has attracted, both early in its career and more recently, are worth more than a brief summary. What do we now make, for example, of Richard Kostelanetz's forthright accusation that 'The New York Review was from its origins destined to publicize Random House's (and especially [Jason] Epstein's) books and writers'?1 Well, simply that, even if the statistics bear out the charge (and Kostelanetz provides some suggestive evidence to support it, at least with respect to some early issues), there is nothing surprising in a market economy about a publisher trying to push his books through the pages of a journal edited by his friends. True, the New York Review has not had room to review more than around fifteen books in each issue and there could be a bias in the selection of

http://www.jstor.org/stable/pdfplus/3507774.pdf

The New York Review of Books

Heterogeneous beliefs and routes to chaos in a simple asset pricing model

Econometric policy evaluation: A critique

A crucial challenge for economists is figuring out how people interpret the world and form expectations that will likely influence their economic activity. Inflation, asset prices, exchange rates, investment, and consumption are just some of the economic variables that are largely explained by expectations. Here George Evans and Seppo Honkapohja bring new explanatory power to a variety of expectation formation models by focusing on the learning factor. Whereas the rational expectations paradigm offers the prevailing method to determining expectations, it assumes very theoretical knowledge on the part of economic actors. Evans and Honkapohja contribute to a growing body of research positing that households and firms learn by making forecasts using observed data, updating their forecast rules over time in response to errors. This book is the first systematic development of the new statistical learning approach. Depending on the particular economic structure, the economy may converge to a standard rational-expectations or a "rational bubble" solution, or exhibit persistent learning dynamics. The learning approach also provides tools to assess the importance of new models with expectational indeterminacy, in which expectations are an independent cause of macroeconomic fluctuations. Moreover, learning dynamics provide a theory for the evolution of expectations and selection between alternative equilibria, with implications for business cycles, asset price volatility, and policy. This book provides an authoritative treatment of this emerging field, developing the analytical techniques in detail and using them to synthesize and extend existing research.

Learning and expectations in macroeconomics

Commitment in monetary policy leads to equilibria that are superior to those from optimal discretionary policies. A number of interest-rate reaction functions and instrument rules have been proposed to implement or approximate commitment policy. We assess these rules in terms of whether they lead to a rational expectations equilibrium that is both locally determinate and stable under adaptive learning by private agents. A reaction function that appropriately depends explicitly on private sector expectations performs particularly well on both counts.

/pdf/monetary-policy-expectations-and-commitment-kae12y6un1.pdf

Monetary policy, expectations and commitment

Eine auf den Fundamentaldaten beruhende Regelbindung der Geldpolitik ohne Selbstverpflichtung, die bei vollkommen rationalen Erwartungen der privaten Akteure optimal ware, ist instabil, wenn diese Akteure de facto den ublichen Regeln des adaptiven Lernens folgen. Dieses Problem lasst sich dadurch beheben, dass die Erwartungen privater Akteure berucksichtigt und in geeigneter Weise in die optimale Geldpolitik einbezogen werden. Diese eindeutige Schlusfolgerung gilt auch dann, wenn sich der geldpolitische Entscheidungstrager und die privaten Akteure in einem simultanen Lernprozess befinden. Unsere Ergebnisse zeigen, wie wichtig es ist, die Geldpolitik angemessen zu gestalten und dabei nicht nur die Fundamentaldaten, sondern auch direkt die beobachteten Erwartungen privater Haushalte und Unternehmen zu berucksichtigen.

/pdf/expectations-and-the-stability-problem-for-optimal-monetary-3mgb5ljozw.pdf

Expectations and the stability problem for optimal monetary policies

Finland's depression A tale of bad luck and bad policies

In the 1990s, Finland underwent a deep depression as its GDP dropped about 14% and unemployment rose from 3 to almost 20%. This is a story of bad luck and bad policies. Bad luck took the form of external shocks: the collapse of trade with the former Soviet Union in 1991, but also sharp cycles in the OECD area. However, bad luck is far from being the whole story. In the absence of bad policies, Finland would have experienced a recession, not a depression. Bad policies included a poorly designed financial regulation and mistaken reactions to the onset of the crisis. Of particular interest is the role of financial factors in triggering the crisis and aggravating the effects of bad policies. Not only were consumption and investment spending hurt by the credit crunch, but there is evidence that the private sector’s indebtedness has increased structural unemployment, which explains why the recovery is proceeding with few job creations. A number of general lessons emerge. They concern the deregulation of financial markets, the policy reaction to massive capital inflows and the role of employment policies.

— Seppo Honkapohja and Erkki Koskela

/pdf/the-economic-crisis-of-the-1990s-in-finland-1wv3qn8rpv.pdf

The economic crisis of the 1990s in Finland

We review the recent work on interest rate setting, which emphasizes the desirability of designing policy to ensure stability under private agent learning.Appropriately designed expectations based rules can yield optimal rational expectations equilibria that are both determinate and stable under learning.Some simple instrument rules and approximate targeting rules also have these desirable properties.We take up various complications in implementing optimal policy, including the observability of key variables and the required knowledge of structural parameters.An additional issue that we take up concerns the implications of expectation shocks not arising from transitional learning effects. Key words: commitment, interest rate setting, adaptive learning, stability, determinacy, expectations shocks JEL classification numbers: E52, E31, D84

/pdf/adaptive-learning-and-monetary-policy-design-4l8lmkyhd6.pdf

Seppo Honkapohja

Papers

Learning and expectations in macroeconomics

Monetary policy, expectations and commitment

Expectations and the stability problem for optimal monetary policies

The economic crisis of the 1990s in Finland

Adaptive Learning and Monetary Policy Design