The Science of Monetary Policy: An Imperfect Knowledge Perspective

New Keynesian theory identifies a set of principles central to the design and
implementation of monetary policy. These principles rely on the ability of a central bank
to manage expectations precisely, with policy prescriptions typically derived under the
assumption of perfect information and full rationality. In consequence the prevailing
policy regime is credible and correctly understood by market participants. Despite
considerable advances in understanding, recent events have engendered a reevaluation
of the theory and practice of monetary policy. The challenging
macroeconomic environment bequeathed by the financial crisis has led many to question
the efficacy of monetary policy, and, particularly, question whether central banks can
influence expectations with as much control as previously thought. The objective of this
survey is to review what is understood about the challenges to the New Keynesian
paradigm posed by imperfect knowledge and to assess the degree of confidence with
which one should hold the basic prescriptions of modern monetary economics.