Rule-of-Thumb Behaviour and Monetary Policy

The authors investigate the implications of rule-of-thumb behavior on the part of consumers or price setters for optimal monetary policy and simple interest rate rules. The existence of such behavior leads to endogenous persistence in output and inflation; changes the transmission of shocks to these...

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Bibliographic Details
Published in:Policy File 2002
Main Authors: Amato, Jeffery D, Laubach, Thomas
Format: Report
Language:English
Subjects:
Banking/Finance
Consumers
Economic policy
The Federal Reserve Board
Online Access:Request full text
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Summary:The authors investigate the implications of rule-of-thumb behavior on the part of consumers or price setters for optimal monetary policy and simple interest rate rules. The existence of such behavior leads to endogenous persistence in output and inflation; changes the transmission of shocks to these variables; and alters the policymaker's welfare objective. Their main finding is that highly inertial policy is optimal regardless of what fraction of agents occasionally follow a rule of thumb. They also find that the interest rate rule that implements optimal policy in the purely optimizing case, and a first-difference version of Taylor's (1993) rule, have desirable properties in all of the cases they consider. By contrast, the coefficients in other optimized simple rules tend to be extremely sensitive with respect to the fraction of rule-of-thumb behavior and changes in other parameters of the model.