Rule-of-thumb behaviour and monetary policy

We investigate the implications of rule-of-thumb behaviour by consumers or price setters for optimal monetary policy and simple interest rate rules. This behaviour leads to endogenous persistence in output and inflation and alters the policymaker's welfare objective. Our main finding is that hi...

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Bibliographic Details
Published in:European economic review 2003-10, Vol.47 (5), p.791-831
Main Authors: Amato, Jeffery D., Laubach, Thomas
Format: Article
Language:English
Subjects:
Consumers
Economic behaviour
Economic models
Economic policy
Economic theory
Economics
Inflation
Interest rate rules
Interest rates
Monetary policy
Optimal monetary policy
Rule of thumb
Rules
Studies
Welfare policy
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Summary:We investigate the implications of rule-of-thumb behaviour by consumers or price setters for optimal monetary policy and simple interest rate rules. This behaviour leads to endogenous persistence in output and inflation and alters the policymaker's welfare objective. Our main finding is that highly inertial policy is optimal regardless of what fraction of agents occasionally follow a rule of thumb. We also find that a first-difference version of Taylor's (Carnegie–Rochester Conf. Ser. Public Policy 39 (1993) 195–214) rule generally has desirable properties. By contrast, the coefficients in other optimised simple rules tend to be extremely sensitive with respect to the fraction of rule-of-thumb behaviour.
ISSN:0014-2921
1873-572X
DOI:10.1016/S0014-2921(02)00270-2