NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Robustly Optimal Monetary Policy with Near Rational Expectations

Michael Woodford

NBER Working Paper No. 11896
Issued in December 2005
NBER Program(s):   EFG   ME

The paper considers optimal monetary stabilization policy in a forward-looking model, when the central bank recognizes that private-sector expectations need not be precisely model-consistent, and wishes to choose a policy that will be as good as possible in the case of any beliefs that are close enough to model-consistency. The proposed method offers a way of avoiding the assumption that the central bank can count on private-sector expectations coinciding precisely with whatever it plans to do, while at the same time also avoiding the equally unpalatable assumption that the central bank can precisely model private-sector learning and optimize in reliance upon a precise law of motion for expectations.

The main qualitative conclusions of the rational-expectations analysis of optimal policy carry over to the weaker assumption of near-rational expectations. It is found that commitment continues to be important for optimal policy, that the optimal long-run inflation target is unaffected by the degree of potential distortion of beliefs, and that optimal policy is even more history-dependent than if rational expectations are assumed.

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Document Object Identifier (DOI): 10.3386/w11896

Published:

  • Woodford, Michael. “An Example of Robustly Optimal Monetary Policy with Near-Rational Expectations.” Journal of the European Economics Association 4, 2-3 (2006): 386-395. ,
  • Michael Woodford, 2010. "Robustly Optimal Monetary Policy with Near-Rational Expectations," American Economic Review, American Economic Association, vol. 100(1), pages 274-303, March.

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