This paper develops a small forward-looking macroeconomic model where the Federal Reserve estimates the level of potential output in real time by running a regression on past output data. The Fed's perceived output gap is used as an input to the monetary policy rule while the true output gap...

This paper examines the optimal monetary policy under discretion using a small macroeconomic model that allows for varying degrees of forward-looking behavior. We quantify how forward-looking behavior affects the optimal response to inflation and the output gap in the central bank's interest...