Misperceptions and monetary policy in a New Keynesian model

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 30 September 2005

Working Paper No. 278
By Jarkko Jääskelä and Jack McKeown

This paper studies the consequences for the monetary policy design of information shortages on the part of the private sector. We model these shortages as exogenous shocks to expected output, which through an IS curve, disturb demand and output themselves. We constrain policymakers to follow Taylor-like rules but allow them to optimise coefficients: we find that the presence of misperceptions makes the optimised Taylor rule respond more aggressively to inflation and the output gap. We also find that if the policymaker is uncertain about misperceptions, then it is less costly to assume they are pervasive when they are not than the reverse. In other words, setting policy on the basis that the private sector is subject to misperceptions is a ‘robust’ policy.

PDFMisperceptions and monetary policy in a New Keynesian model

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