Optimal Monetary Policy Rules in a Behavioural New Keynesian Model

ABSTRACT This study explores optimal monetary policy rules under commitment in a behavioural new Keynesian (NK) model. We show how the degree of cognitive discounting affects the properties of the optimal monetary policy rule. Our findings are summarised as follows. First, allowing predominant cognitive discounting may render the optimal rule ineffective because it is less likely to impart policy inertia into the economy. Second, despite the degree of nominal price stickiness, the costs of a discretionary policy can be relatively smaller in a behavioural NK model than in the standard NK model. Third, the degree of cognitive discounting influences the properties of optimal monetary policy rules under the zero lower bound on the nominal interest rate. Finally, the degree of interest rate stabilisation in the loss function is crucial in explaining the properties of optimal monetary policy in a behavioural NK model.