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Monetary policy in an estimated optimisation-based model with sticky prices and wages

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Author Info

  • Thomas Laubach

    (Federal Reserve Board)

  • Jeffery D. Amato

    (Goldman Sachs International)

Abstract

This paper serves two purposes. First, it provides estimates of an optimisation-based equilibrium model with sticky prices and wages. Second, the estimated model is used to analyse the welfare properties of various interest rate rules for conducting monetary policy. As shown by Erceg et al (1999), an important feature of this model is that it involves a trade-off between the variances of price and wage inflation and the output gap. This trade-off implies that it is desirable for the monetary authority to respond to more than inflation, output and past interest rates when setting the current interest rate. Indeed, the welfare optimal policy can be approximated with responses to both price and wage inflation and the past interest rate. By contrast, rules that call for a strong response to either detrended output or the output gap result in much lower level of welfare.

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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 87.

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Length: 46 pages
Date of creation: May 2000
Date of revision:
Handle: RePEc:bis:biswps:87

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References

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  1. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1997. "Sticky price and limited participation models of money: A comparison," European Economic Review, Elsevier, Elsevier, vol. 41(6), pages 1201-1249, June.
  2. Ireland, Peter N., 2004. "A method for taking models to the data," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 28(6), pages 1205-1226, March.
  3. 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.
  4. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 2(1), pages 1-53, February.
  5. Jeremy Berkowitz & Lutz Kilian, 2000. "Recent developments in bootstrapping time series," Econometric Reviews, Taylor & Francis Journals, Taylor & Francis Journals, vol. 19(1), pages 1-48.
  6. Ben S. Bernanke & Ilian Mihov, 1995. "Measuring Monetary Policy," NBER Working Papers 5145, National Bureau of Economic Research, Inc.
  7. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
  8. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
  9. Christopher J. Erceg, 1997. "Nominal wage rigidities and the propagation of monetary disturbances," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 590, Board of Governors of the Federal Reserve System (U.S.).
  10. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  11. Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 47-64.
  12. Casey B. Mulligan, 1999. "Substition over Time: Another Look at Life-Cycle Labor Supply," NBER Chapters, in: NBER Macroeconomics Annual 1998, volume 13, pages 75-152 National Bureau of Economic Research, Inc.
  13. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 1(1), pages 19-46, January.
  14. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters, in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
  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. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999, Society for Computational Economics 1151, Society for Computational Economics.
  17. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
  18. Kim, Jinill, 2000. "Constructing and estimating a realistic optimizing model of monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 45(2), pages 329-359, April.
  19. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  20. Ireland, Peter N., 1997. "A small, structural, quarterly model for monetary policy evaluation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 47(1), pages 83-108, December.
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Citations

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Cited by:
  1. Coenen, Günter & Wieland, Volker, 2002. "A Small Estimated Euro Area Model with Rational Expectations and Nominal Rigidities," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3574, C.E.P.R. Discussion Papers.
  2. Coenen, Gunter, 2007. "Inflation persistence and robust monetary policy design," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 31(1), pages 111-140, January.
  3. Frank Smets & Raf Wouters, 2002. "Monetary policy in an estimated stochastic dynamic general equilibrium model of the Euro area," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  4. Katharine S. Neiss and Edward Nelson, 2001. "The Real Interest Rate Gap as an Inflation Indicator," Computing in Economics and Finance 2001, Society for Computational Economics 145, Society for Computational Economics.
  5. Argia M. Sbordone, 2001. "An Optimizing Model of U.S. Wage and Price Dynamics," Departmental Working Papers, Rutgers University, Department of Economics 200110, Rutgers University, Department of Economics.
  6. Gunter Coenen & Volker Wieland, 2000. "A Simple Estimated Euro Area Model With Rational Expectations And Nominal Rigidities," Computing in Economics and Finance 2000, Society for Computational Economics 187, Society for Computational Economics.
  7. Seonghoon Cho & Antonio Moreno, 2003. "A Structural Estimation and Interpretation of the New Keynesian Macro Model," Faculty Working Papers, School of Economics and Business Administration, University of Navarra 14/03, School of Economics and Business Administration, University of Navarra.
  8. Thomas Laubach & Jeffery D. Amato, 2000. "Forecast-based monetary policy," BIS Working Papers 89, Bank for International Settlements.
  9. Alves, Sergio A Lago & Bugarin, Mirta N S, 2006. "The Role of Consumer's Risk Aversion on Price Rigidity," Computing in Economics and Finance 2006, Society for Computational Economics 128, Society for Computational Economics.
  10. Jean Boivin & Marc Giannoni, 2002. "Has monetary policy become less powerful?," Staff Reports, Federal Reserve Bank of New York 144, Federal Reserve Bank of New York.
  11. Jondeau, E. & Le Bihan, H., 2001. "Testing for a Forward-Looking Phillips Curve. Additional Evidence from European and US Data," Working papers, Banque de France 86, Banque de France.

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