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Optimal monetary policy rules in a rational expectations model of the Phillips curve

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  • Clark, Peter B.
  • Goodhart, Charles A. E.
  • Huang, Haizhou

Abstract

In this paper we construct a rational expectations model based on a Phillips curve that embodies persistence in inflation. As we assume that the central bank targets the natural rate of output, there is no inflation bias. We derive optimal monetary policy rules that are state-contingent and shock-dependent both in the case where the central bank follows a commitment strategy and where it pursues a discretionary procedure. Numerical solutions show that in the state-contingent part there always exists a trade-off between these two optimal rules, in that the commitment rule involves smaller expected deviations of inflation from its target; in the shock-dependent part there can be situations in which the discretionary rule is more effective in reducing the impact of the random shock on inflation and less effective in reducing the random shock on output. Only in the latter case it is possible that one rule is superior; otherwise it is generally the case that a trade-off exists between these two rules.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 43 (1999)
Issue (Month): 2 (April)
Pages: 497-520

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Handle: RePEc:eee:moneco:v:43:y:1999:i:2:p:497-520

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Web page: http://www.elsevier.com/locate/inca/505566

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  1. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  2. Douglas Laxton & Guy Meredith & David Rose, 1995. "Asymmetric Effects of Economic Activity on Inflation: Evidence and Policy Implications," IMF Staff Papers, Palgrave Macmillan, vol. 42(2), pages 344-374, June.
  3. Lars E.O. Svensson, 1995. "Optimal Inflation Targets, `Conservative' Central Banks, and Linear Inflation Contracts," NBER Working Papers 5251, National Bureau of Economic Research, Inc.
  4. Fuhrer, Jeffrey C & Moore, George R, 1995. "Monetary Policy Trade-offs and the Correlation between Nominal Interest Rates and Real Output," American Economic Review, American Economic Association, vol. 85(1), pages 219-39, March.
  5. Douglas Laxton & Peter B. Clark & David Rose, 1995. "Asymmetry in the U.S. Output-Inflation Nexus," IMF Working Papers 95/76, International Monetary Fund.
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  7. Lockwood, B. & Miller, M. & Zhang, L., 1994. "Designing Monetary Policy when Unemployment Persists," Discussion Papers 9408, Exeter University, Department of Economics.
  8. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
  9. Lockwood, Ben & Philippopoulos, Apostolis, 1994. "Insider Power, Unemployment Dynamics and Multiple Inflation Equilibria," Economica, London School of Economics and Political Science, vol. 61(241), pages 59-77, February.
  10. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
  11. Robert P. Flood & Peter Isard, 1989. "Monetary Policy Strategies," IMF Staff Papers, Palgrave Macmillan, vol. 36(3), pages 612-632, September.
  12. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  13. repec:fth:exetec:94-08 is not listed on IDEAS
  14. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  15. Charles Goodhart & Haizhou Huang, 1995. "What is the Central Banks Game?," FMG Discussion Papers dp222, Financial Markets Group.
  16. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  17. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  18. Willem H. Buiter, 1981. "The Superiority of Contingent Rules over Fixed Rules in Models with Rational Expectations," NBER Technical Working Papers 0009, National Bureau of Economic Research, Inc.
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