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Exact Utilities under Alternative Monetary Rules in a Simple Macro Model with Optimizing Agents

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  • Dale Henderson
  • Jinill Kim

Abstract

We construct an optimizing-agent model of a closed economy which is simple enough that we can use it to make exact utility calculations. There is a stabilization problem because there are one-period nominal contracts for wages, or prices, or both and shocks that are unknown at the time when contracts are signed. We evaluate alternative monetary policy rules using the utility function of the representative agent. Fully optimal policy can attain the Pareto-optimal equilibrium. Fully optimal policy is contrasted with both 'naive' and 'sophisticated' simple rules that involve, respectively, complete stabilization and optimal stabilization of one variable or a combination two variables. With wage contracts, outcomes depend crucially on whether there are also price contracts. For example, if labor supply is relatively inelastic, for productivity shocks, nominal income stabilization yields higher welfare when there are no price contracts. However, with price contracts, outcomes are independent of whether there are wage contracts, except, of course, for the nominal wage. Copyright Kluwer Academic Publishers 1999

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File URL: http://hdl.handle.net/10.1023/A:1008797231729
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Bibliographic Info

Article provided by Springer in its journal International Tax and Public Finance.

Volume (Year): 6 (1999)
Issue (Month): 4 (November)
Pages: 507-535

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Handle: RePEc:kap:itaxpf:v:6:y:1999:i:4:p:507-535

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Web page: http://www.springerlink.com/link.asp?id=102915

Related research

Keywords: monetary policy; stabilization; sticky wages; sticky prices; wage contracts; price contracts;

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References

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  1. Giancarlo Corsetti & Paolo Pesenti, 1997. "Welfare and Macroeconomic Interdependence," NBER Working Papers 6307, National Bureau of Economic Research, Inc.
  2. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-19, December.
  3. Evan F. Koenig, 1995. "Targeting nominal income: a closer look," Working Papers 9518, Federal Reserve Bank of Dallas.
  4. Charles Engel, 1999. "On the Foreign-Exchange Risk Premium in Sticky-Price General Equilibrium Models," NBER Working Papers 7067, National Bureau of Economic Research, Inc.
  5. Canzoneri, Matthew B & Cumby, Robert & Diba, Behzad, 1998. "Is the Price Level Determined by the Needs of Fiscal Solvency?," CEPR Discussion Papers 1772, C.E.P.R. Discussion Papers.
  6. Dale W. Henderson & Jinill Kim, 1999. "Exact utilities under alternative monetary rules in a simple macro model with optimizing agents," International Finance Discussion Papers 635, Board of Governors of the Federal Reserve System (U.S.).
  7. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  8. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296 National Bureau of Economic Research, Inc.
  9. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  10. Jinill Kim, 1997. "Three sources of increasing returns to scale," Finance and Economics Discussion Series 1997-18, Board of Governors of the Federal Reserve System (U.S.).
  11. Fukuda, Shin-ichi & Hoshi, Takeo & Ito, Takatoshi & Rose, Andrew, 2006. "International Finance," Journal of the Japanese and International Economies, Elsevier, vol. 20(4), pages 455-458, December.
  12. Michael B. Devereux & Charles Engel, 1998. "Fixed vs. Floating Exchange Rates: How Price Setting Affects the Optimal Choice of Exchange-Rate Regime," NBER Working Papers 6867, National Bureau of Economic Research, Inc.
  13. Ireland, Peter N., 1997. "A small, structural, quarterly model for monetary policy evaluation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 83-108, December.
  14. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
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