Monetary policy with imperfect signals: The target problem in a new monetarist approach

The target problem considers the central bank's use of optimal tools and targets for purposes of stabilization and welfare optimization. In this study, this question is answered anew in a microfounded approach. By adding imperfect information to the model of [Berentsen and Waller, 2011], a divide between an interest rate policy and a money stock policy emerges. Given this, the usefulness of each policy is analyzed, with the ultimate result being the dominance of a pro-cyclical interest rate-based policy. This finding stands in contrast to the well-known macrofounded answer of [Poole, 1970]. The inconsistency is resolved by an examination of some of the axioms underlying New Keynesian and New Monetarist models.