Roberto M. Billi
Sveriges Riksbank
Policymakers often use the output gap to guide monetary policy, even though inflation and nominal gross domestic product (NGDP) are measured more accurately in real time. Employing a small New Keynesian model with a zero lower bound (ZLB) on nominal interest rates, this article compares the performance of monetary policy rules that are robust to persistent measurement errors. It shows that, in the absence of the ZLB, the central bank should focus on stabilizing inflation rather than nominal GDP. But when the ZLB is present, a policy that seeks to stabilize nominal GDP improves substantially the tradeoffs faced by the central bank.
JEL Code: E31, E52, E58.
Full article (PDF, 28 pages, 521 kb)