Indicator variables for optimal policy

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. (C) 2003 Published by Elsevier Science B.V.