On the optimal monetary policy response to noisyindicators

We describe a behavior of a central bank when its measures of current inflation and outputare subject to measurement errors, in a framework of optimizing models with nominal pricestickiness. In our model, a central bank sets the interest rate equal to its current estimate of theso-called Wicksellian natural rate of interest. This is shown to imply that the interest rateresponds to the central bank’s estimates of both current inflation and output gap, as advocatedby Taylor (1993)...