Indicator Variables for Optimal Policy

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Lars E.O. Svensson
Princeton University,


Michael Woodford
Columbia and NBER

First Draft: November 1999
This Version: April 2003

Journal of Monetary Economics 50 (2003) 691-720


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. An example of optimal monetary policy with a partially observable potential output and a forward-looking indicator is examined. The optimal response to the optimal estimate of potential output displays certainty-equivalence, whereas the optimal response to the imperfect observation of output depends on the noise in this observation.

JEL Classification: E37, E47, E52, E58

Keywords: Partial information, Kalman filter, monetary policy,
discretion and commitment