“Having looked at monetary policy from both sides now, I can testify that central banking in practice is as much art as science. Nonetheless, while practicing this dark art, I have always found the science quEite useful.” 2 Alan S. Blinder

We examine to what extent variants of inflation-forecast targeting can avoid stabilization bias, incorporate history-dependence, and achieve determinacy of equilibrium, so as to reproduce a socially optimal equilibrium. We also evaluate these variants in terms of the transparency of the connection with the ultimate policy goals and the robustness to model perturbations. A suitably designed inflation-forecast targeting rule can achieve the social optimum and at the same time have a more transparent connection to policy goals and be more robust than competing instrument rules.

The economic theory of rationality promises to equal mathematical logic in its importance for the mechanization of reasoning. We survey the growing literature on how the basic notions of probability, utility, and rational choice, coupled with practical limitations on information and resources, influence the design and analysis of reasoning and representation systems. 1 Introduction People make judgments of rationality all the time, usually in criticizing someone else's thoughts or deeds as irrational, or in defending their own as rational. Artificial intelligence researchers construct systems and theories to perform or describe rational thought and action, criticizing and defending these systems and theories in terms similar to but more formal than those of the man or woman on the street. Judgments of human rationality commonly involve several different conceptions of rationality, including a logical conception used to judge thoughts, and an economic one used to judge actions or...

It is argued that inflation targeting is best understood as a commitment to a targeting rule rather than an instrument rule, eitherageneral targeting rule (explicit objectives for monetary policy) or a specific targeting rule (a criterion for (the forecasts of) the target variables to be fulfilled), essentially the equality of the marginal rates of transformation and substitution between the target variables. Targeting rules allow the use of judgment and extramodel information, are more robust and easier to verify than optimal instrument rules, and they can nevertheless bring the economy close to the socially optimal equilibrium.

It is a pleasure to be asked to comment upon Lars Svensson’s thoughtful and ambitious paper, though it raises far too many issues for me to attempt to address them all in the limited time available here. Svensson offers a thorough review of the recent scholarly literature on the conduct of monetary policy, and also reviews one of the most important recent developments in central bank practice as well, namely the evolving methodology of “inflation forecast targeting.” In my own remarks, I would like to develop further a single theme, which is the advantage of central bank commitment to a systematic approach to monetary policy. This theme also figures in Svensson’s discussion, but I believe that its consequences extend even further than he indicates.

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We define and study transparency, credibility, and reputation in a model where the central banks characteristics are unobservable to the private sector and inferred from the policy outcome. A low-credibility bank optimally conducts a more expansionary policy than a high-credibility bank, in the sense that it induces higher inflation, but a less expansionary policy in the sense that it induces lower inflation and employment than expected. Increased transparency makes the banks reputation and credibility more sensitive to its actions. This moderates the banks policy, and induces the bank to follow a policy closer to the socially optimal one. Full transparency of the central banks intentions is generally socially beneficial, but frequently not in the interest of the bank. Somewhat paradoxically, direct observability of idiosyncratic central bank goals removes the moderating influence on the bank and leads to the worst equilibrium.

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This paper reviews the distinction between the timeless perspective and discretionary modes of monetary policymaking, the former representing rule-based policy as recently formalized by Woodford (1999b). In models with forward-looking expectations there is typically a second inefficiency from discretionary policymaking, besides the inflationary bias. The paper presents calculations of the quantitative magnitude of this second inefficiency, using calibrated models of two prominent types; examines the distinction between instrument rules and targeting rules; and briefly investigates operationality issues involving the unobservability of current output and the possibility that an incorrect concept of the natural-rate level of output is used by the policymaker.

This paper studies optimal monetary policy in a model where inflation is persistent. Two types of price setters are assumed to exist. One acts rationally given Calvo-type constraints on price setting. The other type sets prices according to a rule-of-thumb. This results in a Phillips curve with both a forward-looking term and a backward-looking term. The Phillips curve nests a standard purely forward-looking Phillips curve as well as a standard purely backward-looking Phillips curve as special cases. A cost push supply shock is derived from microfoundations by adding a time varying income tax and by making the elasticity of substitution between goods stochastic. A central bank loss function for this model is derived from a second order Taylor approximation of the welfare. Optimal monetary policy for different relative values of the forward- and backward-looking terms is then analyzed for both the commitment case and the case of discretion.