Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 688: Indicator Variables for Optimal Policy

Lars Svensson () and Michael Woodford
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Lars Svensson: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 69 Stockholm
Michael Woodford: Princeton University and NBER

Abstract: The optimal weights on indicators in models with partial information about the state of the economy and forward-looking variables are derived and interpreted, both for equilibria under discretion and under commitment. An example of optimal monetary policy with a partially observable potential output and a forward-looking indicator is examined. The optimal response to the optimal estimate of potential output displays certainty-equivalence, whereas the optimal response to the imperfect observation of output depends on the noise in this observation.

Keywords: Partial information; Kalman filter; monetary policy; discretion and commitment

JEL-codes: E37; E47; E52; E58

53 pages, September 1, 2000

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