Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 689: Indicator Variables for Optimal Policy under Asymmetric Information

Lars E. O. Svensson () and Michael Woodford
Additional contact information
Lars E. O. Svensson: Princeton University, Postal: Department of Economics, Fisher Hall, Princeton University, Princeton, NJ 08544-1021, US
Michael Woodford: Princeton University, Postal: Department of Economics, , Princeton University, , Princeton, NJ 08544-1021

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. The private sector is assumed to have information about the state of the economy that the policymaker does not possess. Certainty-equivalence is shown to apply, in the sense that optimal policy reactions to optimally estimated states of the economy are independent of the degree of uncertainty. The usual separation principle does not hold, since the estimation of the state of the economy is not independent of optimization and is in general quite complex. We present a general characterization of optimal filtering and control in settings of this kind, and discuss an application of our methods to the problem of the optimal use of "real-time" macroeconomic data in the conduct of monetary policy.

Keywords: Partial information; Kalman filter; monetary policy; discretion and commitment; certainty equivalence; separation principle

JEL-codes: E37; E47; E52; E58

36 pages, February 15, 2001

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