Abstract
We consider the impact of pessimism on monetary policy within a model with backward looking expectations and persistence in the dynamics of output and inflation. We show that pessimistic monetary authorities move their instruments to hedge against the worst economic shocks. With respect to their risk-neutral counterparts, they apply a more aggressive Taylor rule, so that the inflation rate is less volatile. Our conclusions hold when the monetary authorities observe inflation and output with a time lag. Our analysis extends that of van der Ploeg (2009), as we allow for time-discounting of future social welfare losses due to deviations of output and inflation from first-best values.
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