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Abstract

We study optimal monetary policy design in a simple model that deviates from the linear-quadratic paradigm and provides a rationale for the practice of inflation zone targeting. We show that the presence of either zone-quadratic preferences or a zonelinear relationship between inflation and economic activity provides strong incentives to deviate from conventional linear policies. We calibrate the model based on parameters for the U.S. and the Euro area and employ a numerical dynamic programming algorithm to derive the optimal policies. With this algorithm, we examine the role of uncertainty, model structure and relative preference towards economic stability in determining the width of the implied targeted inflation zone.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 44 (2000)
Issue (Month): 7 (June)
Pages: 1351-1387

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Handle: RePEc:eee:eecrev:v:44:y:2000:i:7:p:1351-1387

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Find related papers by JEL classification:

• E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
• E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
• E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
• E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

References

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