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Home > Catalogue > Imperfect Knowledge and Monetary Policy
Imperfect Knowledge and Monetary Policy


  • 1 table
  • Page extent: 152 pages
  • Size: 216 x 138 mm
  • Weight: 0.33 kg

Library of Congress

  • Dewey number: 332.46
  • Dewey version: 22
  • LC Classification: n/a
  • LC Subject headings:
    • Monetary policy

Library of Congress Record

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 (ISBN-13: 9780521854863 | ISBN-10: 0521854865)

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Imperfect Knowledge and Monetary Policy

Based on lectures given as part of The Stone Lectures in Economics, this book discusses the problem of formulating monetary policy in practice, under the uncertain circumstances which characterize the real world. The first lecture highlights the limitations of decision rules suggested by the academic literature and recommends an approach involving, first, a firm reliance on the few fundamental and robust results of monetary economics and, secondly, a pragmatic attitude to policy implementation, taking into consideration lessons from central banking experience. The second lecture revisits Milton Friedman’s questions about the effects of active stabilization policies on business cycle fluctuations. It explores the implications of a simple model where the policy maker has imperfect knowledge about potential output and the private sector forms expectations according to adaptive learning. This lecture shows that imperfect knowledge limits the scope for active stabilization policy and strengthens the case for conservatism.

OTMAR ISSING is a member of the Executive Board, European Central Bank.

VÍTOR GASPAR is Special Advisor, Banco de Portugal.

ORESTE TRISTANI is Principal Economist, DG Research, European Central Bank.

DAVID VESTIN is Economist, DG Research, European Central Bank.


Already published:
Statistics, Econometrics and Forecasting – Arnold Zellner

Sir Richard Stone, Nobel Laureate in Economics.

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Imperfect Knowledge and Monetary Policy

Otmar Issing and Vítor Gaspar


Oreste Tristani and David Vestin

Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo

Cambridge University Press
The Edinburgh Building, Cambridge CB2 2RU, UK

Published in the United States of America by Cambridge University Press, New York
Information on this title:

© Otmar Issing, Vítor Gaspar, Oreste Tristani and David Vestin 2005

This book is in copyright. Subject to statutory exception
and to the provisions of relevant collective licensing agreements,
no reproduction of any part may take place without
the written permission of Cambridge University Press.

First published 2005

Printed in the United Kingdom at the University Press, Cambridge

A catalogue record for this book is available from the British Library

ISBN-13 978-0-521-85486-3 hardback
ISBN-10 0-521-85486-5 hardback
ISBN-13 978-0-521-67107-1 paperback
ISBN-10 0-521-67107-8 paperback

Cambridge University Press has no responsibility for the persistence or accuracy of URLs for external or third-party internet websites referred to in this book, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate.


List of figures and table page ix
Acknowledgments xi
Introduction 1
  Outline of the two lectures 7
Lecture 1: Monetary policy in uncharted territory 12
1.1 Introduction 12
1.2 Uncharted territory: unique historical events 15
1.3 Achieving price stability 23
1.4 Avoiding excess volatility in inflation, output, and the interest rate 38
1.5 Pragmatic monetarism: the Bundesbank 47
1.6 A stability-oriented strategy: the ECB 61
1.7 Conclusions 74
Lecture 2: Imperfect knowledge, learning, and conservatism 77
2.1 Introduction 77
2.2 Time inconsistency, cost-push shocks and Rogoff ’s conservatism 83
  Empirical output gap uncertainty 96
2.4 Output gap uncertainty, learning, and conservatism 100
2.5 Different degrees of central bank knowledge and information 108
2.6 Conclusions 114
Notes 117
References 122
Index 136

Figures and table

  1.1 CPI Inflation, 1961–2001 page 48
  1.2 Longer-term averages for German M3 and CPI developments, 1971–98 53
  1.3 M3 in Germany, 1988–98 56
  1.4 Annual rate of growth of M3 in Germany, 1988–98 58
  1.5 M3 money growth and HICP inflation in the euro area, 1994–2004 72
  1.6 Longer-term inflation expectations, 1999–2004 73
  2.1 Informational assumptions 87
  2.2 Rational expectations, observable shocks 90
  2.3 Loss: rational expectations with observable shocks 91
  2.4 Private sector learning; central bank has perfect information 94
  2.5 Loss: private sector learning 95
  2.6 Real-time and two-sided estimates for the HP filter, and different UC models, for the euro area, 1980–2000 97
  2.7 Empirical properties of different estimates, euro area data, 1980–2000 99
  2.8 Central bank: imperfect information, private sector with fixed RLS coefficients 102
  2.9 Loss: imperfect information, no private sector learning 103
2.10 Constant gain: learning and imperfect information 105
2.11 Losses with output gap uncertainty and private sector learning 106
2.12 From perfect to imperfect information 110
2.13 Loss functions : from perfect to imperfect information 111
  1.1 Monetary targets and their implementation 51


We wish to thank Klaus Adam, Steve Cecchetti, Athanasios Orphanides, Gerhard Rünstler, Frank Smets, and Caroline Willeke for helpful comments and suggestions on a preliminary draft. Sandrine Corvoisier and Björn Fischer provided excellent research assistance. We also wish to thank Patricia Kearns-Endres and Luisa Rey for editorial assistance and the organizers of the Stone Lectures Series at the Bank of England and at the National Institute for Economic and Social Research for their help. A final thank you to Chris Harrison for ensuring a smooth and pleasant interaction between the authors and the publisher

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