First Draft: January 1999
This Version: June 2002
Journal of Economic Dynamics and Control 28 (2004) 661-690
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 more information about the state of the
economy than the policymaker. Certainty equivalence holds for the optimal
reaction function in state-space form: the coefficients are independent
of the degree of uncertainty about the state of the economy. However, in the
case of commitment, certainty equivalence does not hold for the reaction
function in integrative form: the policy instrument cannot be written as
a distributed lag of past estimates of past states of the economy. Instead,
optimal policy will generally depend on new estimates of past states of the
economy, and in ways that depend on the information structure. Furthermore, 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.
JEL Classification: E37, E47, E52, E58
Keywords: Partial information, Kalman filter, monetary policy, discretion and commitment, certainty equivalence, separation principle.