Advanced Search
MyIDEAS: Login to save this article or follow this journal

Optimal Monetary Policy

Contents:

Author Info

  • Aubhik Khan
  • Robert G. King
  • Alexander L. Wolman

Abstract

Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two sets of frictions—costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods—we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible. In our benchmark model, there is some tendency for the monetary authority to smooth nominal and real interest rates. Copyright 2003, Wiley-Blackwell.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://hdl.handle.net/10.1111/1467-937X.00269
Download Restriction: Access to full text is restricted to subscribers.

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Article provided by Oxford University Press in its journal The Review of Economic Studies.

Volume (Year): 70 (2003)
Issue (Month): 4 ()
Pages: 825-860

as in new window
Handle: RePEc:oup:restud:v:70:y:2003:i:4:p:825-860

Contact details of provider:

Related research

Keywords:

Other versions of this item:

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  2. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, Elsevier, vol. 44(2), pages 195-222, October.
  3. Sbordone, A.M., 1998. "Prices and Unit Labor Costs: a New Test of Price Stickiness," Papers, Stockholm - International Economic Studies 653, Stockholm - International Economic Studies.
  4. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, Elsevier, vol. 37(2-3), pages 345-370, April.
  5. Marvin Goodfriend & Robert G. King, 2001. "The Case for Price Stability," NBER Working Papers 8423, National Bureau of Economic Research, Inc.
  6. Benveniste, L M & Scheinkman, J A, 1979. "On the Differentiability of the Value Function in Dynamic Models of Economics," Econometrica, Econometric Society, Econometric Society, vol. 47(3), pages 727-32, May.
  7. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  8. Lacker, Jeffrey M. & Schreft, Stacey L., 1996. "Money and credit as means of payment," Journal of Monetary Economics, Elsevier, Elsevier, vol. 38(1), pages 3-23, August.
  9. Alexander L. Wolman, 1999. "Sticky prices, marginal cost, and the behavior of inflation," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Fall, pages 29-48.
  10. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, National Bureau of Economic Research, Inc, in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
  11. Albert Marcet & Ramon Marimon, 1994. "Recursive contracts," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 337, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 1998.
  12. Bernardino Adão & Isabel Horta Correia & Pedro Teles, 2001. "Gaps and Triangles," Working Papers, Banco de Portugal, Economics and Research Department w200102, Banco de Portugal, Economics and Research Department.
  13. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Staff Report, Federal Reserve Bank of Minneapolis 147, Federal Reserve Bank of Minneapolis.
  14. Bennett T. McCallum & Marvin S. Goodfriend, 1986. "Theoretical analysis of the demand for money," Working Paper, Federal Reserve Bank of Richmond 86-03, Federal Reserve Bank of Richmond.
  15. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 195-214, December.
  16. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, Elsevier, vol. 21(1), pages 3-16, January.
  17. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(1), pages 55-93.
  18. Robert G. King & Alexander L. Wolman, 1996. "Inflation targeting in a St. Louis model of the 21st century," Proceedings, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue May, pages 83-107.
  19. Attanasio, Orazio & Guiso, Luigi & Jappelli, Tullio, 1998. "The Demand for Money, Financial Innovation and the Welfare Cost of Inflation: An Analysis with Households' Data," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1927, C.E.P.R. Discussion Papers.
  20. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, Elsevier, vol. 16(3), pages 309-327, November.
  21. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(1), pages 1-23, February.
  22. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  23. Michael Dotsey & Peter Ireland, 1994. "The welfare cost of inflation in general equilibrium," Working Paper, Federal Reserve Bank of Richmond 94-04, Federal Reserve Bank of Richmond.
  24. Robert E. Hall, 1986. "The Relation Between Price and Marginal Cost in U.S. Industry," NBER Working Papers 1785, National Bureau of Economic Research, Inc.
  25. Marvin Goodfriend, 1997. "A framework for the analysis of moderate inflations," Working Paper, Federal Reserve Bank of Richmond 97-04, Federal Reserve Bank of Richmond.
  26. Basu, Susanto & Fernald, John G, 1997. "Returns to Scale in U.S. Production: Estimates and Implications," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 105(2), pages 249-83, April.
  27. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, Econometric Society, vol. 68(2), pages 247-274, March.
  28. Dutton, Dean S & Gramm, William P, 1973. "Transactions Costs, the Wage Rate, and the Demand for Money," American Economic Review, American Economic Association, American Economic Association, vol. 63(4), pages 652-65, September.
  29. Kydland, Finn E. & Prescott, Edward C., 1980. "Dynamic optimal taxation, rational expectations and optimal control," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 2(1), pages 79-91, May.
  30. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296 National Bureau of Economic Research, Inc.
  31. Kimball, Miles S, 1995. "The Quantitative Analytics of the Basic Neomonetarist Model," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 27(4), pages 1241-77, November.
  32. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing And The General Equilibrium Dynamics Of Money And Output," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 114(2), pages 655-690, May.
  33. Ireland, Peter N, 1996. "The Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(4), pages 704-23, August.
  34. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(3), pages 473-91, June.
  35. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 18(2), pages 203-20, April.
  36. Dupor, Bill, 2003. "Optimal random monetary policy with nominal rigidity," Journal of Economic Theory, Elsevier, Elsevier, vol. 112(1), pages 66-78, September.
  37. Harold L. Cole & Narayana R. Kocherlakota, 1998. "Zero nominal interest rates: why they're good and how to get them," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Spr, pages 2-10.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:oup:restud:v:70:y:2003:i:4:p:825-860. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Oxford University Press) or (Christopher F. Baum).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.