Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/153625
Authors: 
Wieland, Volker
Beck, Günter W.
Year of Publication: 
2010
Series/Report no.: 
ECB Working Paper 1191
Abstract: 
In the New-Keynesian model, optimal interest rate policy under uncertainty is formulated without reference to monetary aggregates as long as certain standard assumptions on the distributions of unobservables are satisfied. The model has been criticized for failing to explain common trends in money growth and inflation, and that therefore money should be used as a cross-check in policy formulation (see Lucas (2007)). We show that the New-Keynesian model can explain such trends if one allows for the possibility of persistent central bank misperceptions. Such misperceptions motivate the search for policies that include additional robustness checks. In earlier work, we proposed an interest rate rule that is near-optimal in normal times but includes a cross-check with monetary information. In case of unusual monetary trends, interest rates are adjusted. In this paper, we show in detail how to derive the appropriate magnitude of the interest rate adjustment following a significant cross-check with monetary information, when the New-Keynesian model is the central bank’s preferred model. The cross-check is shown to be effective in offsetting persistent deviations of inflation due to central bank misperceptions.
Subjects: 
European Central Bank
monetary policy
Money
new-Keynesian model
policy under uncertainty
quantity theory
JEL: 
E32
E41
E43
E52
E58
Document Type: 
Working Paper

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