Optimal Monetary Policy Under Bounded Rationality

Author/Editor:

Jonathan Benchimol ; Lahcen Bounader

Publication Date:

August 2, 2019

Electronic Access:

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary:

The form of bounded rationality characterizing the representative agent is key in the choice of the optimal monetary policy regime. While inflation targeting prevails for myopia that distorts agents' inflation expectations, price level targeting emerges as the optimal policy under myopia regarding the output gap, revenue, or interest rate. To the extent that bygones are not bygones under price level targeting, rational inflation expectations is a minimal condition for optimality in a behavioral world. Instrument rules implementation of this optimal policy is shown to be infeasible, questioning the ability of simple rules à la Taylor (1993) to assist the conduct of monetary policy. Bounded rationality is not necessarily associated with welfare losses.

Series:

Working Paper No. 19/166

English

Publication Date:

August 2, 2019

ISBN/ISSN:

9781498324588/1018-5941

Stock No:

WPIEA2019166

Price:

$18.00 (Academic Rate:$18.00)

Format:

Paper

Pages:

52

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