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Optimal Monetary Policy and Price Stability Over the Long-Run

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  • Oleksiy Kryvtsov
  • Malik Shukayev
  • Alexander Ueberfeldt

Abstract

This paper examines the role of monetary policy in an environment with aggregate risk and incomplete markets. In a two-period overlapping-generations model with aggregate uncertainty and nominal bonds, optimal monetary policy attains the ex-ante Pareto optimal allocation. This policy aims to stabilize the savings rate in the economy via the effect of expected inflation on real returns of nominal bonds. The equilibrium under optimal monetary policy is characterized by positive average inflation and a nonstationary price level. In an application a key finding is that optimal monetary policy combines features of inflation and price-level targeting.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 07-26.

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Length: 46 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:bca:bocawp:07-26

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Keywords: Monetary policy framework;

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References

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  1. Campbell, John Y & Mankiw, N Gregory, 1987. "Permanent and Transitory Components in Macroeconomic Fluctuations," American Economic Review, American Economic Association, vol. 77(2), pages 111-17, May.
  2. Per Krusell & Lee E. Ohanian & Jose-Victor Rios-Rull & Giovanni L. Violante, 1997. "Capital-skill complementarity and inequality: a macroeconomic analysis," Staff Report 239, Federal Reserve Bank of Minneapolis.
  3. Svensson, Lars E O, 1996. "Price-level Targeting versus Inflation Targeting: A Free Lunch?," CEPR Discussion Papers 1510, C.E.P.R. Discussion Papers.
  4. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  5. Robert Dittmar & William T. Gavin, 2004. "Inflation-targeting, price-path targeting and indeterminacy," Working Papers 2004-007, Federal Reserve Bank of St. Louis.
  6. Laurence Ball & Niamh Sheridan, 2004. "Does inflation targeting matter?," DNB Staff Reports (discontinued) 118, Netherlands Central Bank.
  7. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  8. Charles T. Carlstrom & Timothy S. Fuerst, 2002. "Monetary policy rules and stability: inflation targeting versus price-level targeting," Economic Commentary, Federal Reserve Bank of Cleveland, issue Feb.
  9. Robert Dittmar & William T. Gavin & Finn E. Kydland, 1999. "Price-level uncertainty and inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 23-34.
  10. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 893-920, October.
  11. Apostolos Serletis, 1992. "The Random Walk in Canadian Output," Canadian Journal of Economics, Canadian Economics Association, vol. 25(2), pages 392-406, May.
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Cited by:
  1. Gino Cateau, 2009. "Optimal Policy under Commitment and Price Level Stationarity," Working Papers 09-8, Bank of Canada.
  2. Bhattacharya, Joydeep & Singh, Rajesh, 2010. "Optimal monetary rules under persistent shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 34(7), pages 1277-1294, July.

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