Advanced Search
MyIDEAS: Login

Inflation Stabilization And Welfare: The Case Of A Distorted Steady State

Contents:

Author Info

  • Pierpaolo Benigno

    (New York University,)

  • Michael Woodford

    (Columbia University,)

Abstract

This paper considers the appropriate stabilization objectives for monetary policy in a micro-founded model with staggered price-setting. Rotemberg and Woodford (1997) and Woodford (2002) have shown that under certain conditions, a local approximation to the expected utility of the representative household in a model of this kind is related inversely to the expected discounted value of a conventional quadratic loss function, in which each period's loss is a weighted average of squared deviations of inflation and an output gap measure from their optimal values (zero). However, those derivations rely on an assumption of the existence of an output or employment subsidy that offsets the distortion due to the market power of monopolis-tically competitive price-setters, so that the steady state under a zero-inflation policy involves an efficient level of output. Here we show how to dispense with this unappealing assumption, so that a valid linear-quadratic approximation to the optimal policy problem is possible even when the steady state is distorted to an arbitrary extent (allowing for tax distortions as well as market power), and when, as a consequence, it is necessary to take account of the effects of stabilization policy on the average level of output. We again obtain a welfare-theoretic loss function that involves both inflation and an appropriately defined output gap, though the degree of distortion of the steady state affects both the weights on the two stabilization objectives and the definition of the welfare-relevant output gap. In the light of these results, we reconsider the conditions under which complete price stability is optimal, and find that they are more restrictive in the case of a distorted steady state. We also consider the conditions under which pure randomization of monetary policy can be welfare-improving, and find that this is possible in the case of a sufficiently distorted steady state, though the parameter values required are probably not empirically realistic. (JEL: D61, E52, E61) Copyright (c) 2005 by the European Economic Association.

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://onlinelibrary.wiley.com/journal/10.1111/(ISSN)1542-4774/issues
File Function: link to full text
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 MIT Press in its journal Journal of the European Economic Association.

Volume (Year): 3 (2005)
Issue (Month): 6 (December)
Pages: 1185-1236

as in new window
Handle: RePEc:tpr:jeurec:v:3:y:2005:i:6:p:1185-1236

Contact details of provider:
Web page: http://www.mitpressjournals.org/jeea

Order Information:
Web: http://www.mitpressjournals.org/jeea

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. Pierpaolo Benigno & Michael Woodford, 2005. "Optimal stabilization policy when wages and prices are sticky: the case of a distorted steady state," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 127-180.
  2. Pierpaolo Benigno & Michael Woodford, 2004. "Optimal monetary and fiscal policy: a linear-quadratic approach," International Finance Discussion Papers 806, Board of Governors of the Federal Reserve System (U.S.).
  3. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  4. Michael Woodford, 2001. "Fiscal Requirements for Price Stability," NBER Working Papers 8072, National Bureau of Economic Research, Inc.
  5. Dupor, Bill, 2003. "Optimal random monetary policy with nominal rigidity," Journal of Economic Theory, Elsevier, vol. 112(1), pages 66-78, September.
  6. Christopher A. Sims & Jinill Kim & Sunghyun Kim, 2004. "Calculating and Using Second Order Accurate Solution of Discrete Time Dynamic Equilibrium Models," Econometric Society 2004 North American Winter Meetings 411, Econometric Society.
  7. Gianluca Benigno & Pierpaolo Benigno, 2004. "Designing Target Rules for International Monetary Policy Cooperation," CEP Discussion Papers dp0666, Centre for Economic Performance, LSE.
  8. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  9. 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.
  10. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  11. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2002. "Optimal Monetary Policy," NBER Working Papers 9402, National Bureau of Economic Research, Inc.
  12. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1998. "Sticky price models of the business cycle: can the contract multiplier solve the persistence problem?," Staff Report 217, Federal Reserve Bank of Minneapolis.
  13. 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.
  14. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," NBER Working Papers 9419, National Bureau of Economic Research, Inc.
  15. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  16. Mark Gertler & Kenneth Rogoff, 2004. "NBER Macroeconomics Annual 2003, Volume 18," NBER Books, National Bureau of Economic Research, Inc, number gert04-1.
  17. Jinill Kim & Sunghyun Kim & Ernst Schaumburg & Christopher A. Sims, 2003. "Calculating and Using Second Order Accurate Solutions of Discrete Time," Levine's Bibliography 666156000000000284, UCLA Department of Economics.
  18. Michael Woodford & Pierpaolo Benigno, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," 2004 Meeting Papers 481, Society for Economic Dynamics.
  19. Benigno, Gianluca & Benigno, Pierpaolo, 2003. "Designing targeting rules for international monetary policy cooperation," Working Paper Series 0279, European Central Bank.
  20. Alan Sutherland, 2002. "A Simple Second-Order Solution Method for Dynamic General Equilibrium Models," Discussion Paper Series, Department of Economics 200211, Department of Economics, University of St. Andrews.
  21. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 277-316.
  22. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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:tpr:jeurec:v:3:y:2005:i:6:p:1185-1236. 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: (Karie Kirkpatrick).

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.