By Vitor Gaspar, Otmar Issing, Oreste Tristani, David Vestin
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Additional info for Imperfect Knowledge and Monetary Policy (The Stone Lectures in Economics)
The target rule hence coincides with optimal policy, and the rule-like element of this approach is represented by the central bank’s commitment to an inflation target and to an optimizing procedure which has to be employed in the actual pursuit of the target (Svensson, 1999b). More recently, Giannoni and Woodford (2002a, 2002b) and Svensson and Woodford (2003) have proposed a class of robust, optimal, explicit instrument rules. As well as minimizing the central bank’s loss function given the structure of the economy, such rules are robust to residual uncertainty.
In order to make progress, policy makers have to complement the available knowledge of modelbased results with their best judgment. Decisions will partly be guided by general and robust theoretical results, and partly be informed by the policy makers’ beliefs on the determinants and effects of a particular development. A limited reliance on judgmental elements is what allows the decision maker to act, based on information that is always too limited and knowledge that is always inadequate. If such elements were banned from policy making, any conscientious decision maker would always conclude that further results are needed before dealing with any practical problem.
4. They become, however, of second order when compared with the fundamental problem of how to avoid true inflation or deflation – that is, inflationary or deflationary spirals. It may be argued that prolonged inflation and deflation are relatively rare events, so central bankers can normally act based mainly on a concern for inflation volatility. This is, however, only known ex post in practical monetary policy making. Ex ante, any small and temporary inflationary shock can potentially reveal itself as the source of an inflationary spiral.
Imperfect Knowledge and Monetary Policy (The Stone Lectures in Economics) by Vitor Gaspar, Otmar Issing, Oreste Tristani, David Vestin