Simplicity versus Optimality: The Choice of Monetary Policy Rules when Agents Must Learn

36 Pages Posted: 18 Dec 2018 Last revised: 18 Jul 2022

See all articles by Robert J. Tetlow

Robert J. Tetlow

Board of Governors of the Federal Reserve System

Peter von zur Muehlen

Federal Reserve Board

Multiple version iconThere are 2 versions of this paper

Date Written: February 1, 2001

Abstract

The normal assumption of full information is dropped and the choice of monetary policy rules is instead examined when private agents must learn the rule. A small, forward-looking model is estimated and stochastic simulations conducted with agents using discounted least squares to learn of a change of preferences or a switch to a more complex rule. We "nd that the costs of learning a new rule may be substantial, depending on preferences and the rule that is initially in place. Policymakers with strong preferences for inflation control incur substantial costs when they change the rule in use, but are nearly always willing to bear the costs. Policymakers with weak preferences for inflation control may actually benefit from agents' prior belief that a strong rule is in place.

Keywords: Monetary policy; Learning

JEL Classification: C5,C6,E5

Suggested Citation

Tetlow, Robert J. and von zur Muehlen, Peter, Simplicity versus Optimality: The Choice of Monetary Policy Rules when Agents Must Learn (February 1, 2001). Journal of Economic Dynamics and Control, Vol. 25, 2001, 245-279, Available at SSRN: https://ssrn.com/abstract=3292463

Robert J. Tetlow

Board of Governors of the Federal Reserve System ( email )

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Peter Von zur Muehlen (Contact Author)

Federal Reserve Board ( email )

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