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Imperfection Information, Optimal Monetary Policy and Informational Consistency

Levine, P., Pearlman, J. and Yang, B. (2013). Imperfection Information, Optimal Monetary Policy and Informational Consistency (Report No. 13/13). London, UK: Department of Economics, City University London.

Abstract

This paper examines the implications of imperfect information (II) for optimal monetary policy with a consistent set of informational assumptions for the modeller and the private sector an assumption we term the informational consistency. We use an estimated simple NK model from Levine et al. (2012), where the assumption of symmetric II significantly improves the fit of the model to US data to assess the welfare costs of II under commitment, discretion and simple Taylor-type rules. Our main results are: first, common to all information sets we find significant welfare gains from commitment only with a zero-lower bound constraint on the interest rate. Second, optimized rules take the form of a price level rule, or something very close across all information cases. Third, the combination of limited information and a lack of commitment can be particularly serious for welfare. At the same time we find that II with lags introduces a ‘tying ones hands’ effect on the policymaker that may improve welfare under discretion. Finally, the impulse response functions under our most extreme imperfect information assumption (output and inflation observed with a two-quarter delay) exhibit hump-shaped behaviour and the fiscal multiplier is significantly enhanced in this case.

Publication Type: Monograph (Discussion Paper)
Additional Information: © 2013 the authors.
Publisher Keywords: Imperfect Information, DSGE Model, Optimal Monetary Policy, Bayesian Estimation
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HJ Public Finance
Departments: School of Arts & Social Sciences > Economics > Discussion Paper Series
URI: http://openaccess.city.ac.uk/id/eprint/2928
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