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Optimal Target Criteria for Stabilization Policy

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  • Marc P. Giannoni

    () (Columbia University - Business School)

  • Michael Woodford

    () (Columbia University - Department of Economics)

Abstract

This paper considers a general class of nonlinear rational-expectations models in which policymakers seek to maximize an objective function that may be household expected utility. We show how to derive a target criterion that is: (i) consistent with the model's structural equations, (ii) strong enough to imply a unique equilibrium, and (iii) optimal, in the sense that a commitment to adjust the policy instrument at all dates so as to satisfy the target criterion maximizes the objective function. The proposed optimal target criterion is a linear equation that must be satisfied by the projected paths of certain economically relevant "target variables." It takes the same form at all times and generally involves only a small number of target variables, regardless of the size and complexity of the model. While the projected path of the economy requires information about the current state, the target criterion itself can be stated without reference to a complete description of the state of the world. We illustrate the application of the method to a nonlinear DSGE model with staggered price-setting, in which the objective of policy is to maximize household expected utility.

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Bibliographic Info

Paper provided by Columbia University, Department of Economics in its series Discussion Papers with number 0910-10.

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Date of creation: 2010
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Handle: RePEc:clu:wpaper:0910-10

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References

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  1. Michael Woodford & Pierpaolo Benigno, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," 2004 Meeting Papers 481, Society for Economic Dynamics.
  2. Lars E O Svensson, 2005. "Monetary Policy with Judgment: Forecast Targeting," International Journal of Central Banking, International Journal of Central Banking, vol. 1(1), May.
  3. Frederic S. Mishkin, 2009. "Monetary Policy Strategy," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262513374.
  4. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  5. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "Optimal monetary policy," Working Papers 01-5, Federal Reserve Bank of Philadelphia.
  6. Pierpaolo Benigno & Michael Woodford, 2008. "Linear-Quadratic Approximation of Optimal Policy Problems," Discussion Papers 0809-01, Columbia University, Department of Economics.
  7. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 825-860.
  8. Marc Paolo Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
  9. Currie,David & Levine,Paul, 2009. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521104609.
  10. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
  11. Backus, David & Driffill, John, 1986. "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," CEPR Discussion Papers 124, C.E.P.R. Discussion Papers.
  12. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  13. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  14. Michael Woodford, 2007. "Forecast Targeting as a Monetary Policy Strategy: Policy Rules in Practice," NBER Working Papers 13716, National Bureau of Economic Research, Inc.
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Cited by:
  1. Stefan Laséen & Lars E.O. Svensson, 2011. "Anticipated Alternative policy Rate Paths in Plicy Simulations," International Journal of Central Banking, International Journal of Central Banking, vol. 7(3), pages 1-35, September.
  2. Michael Woodford, 2010. "Optimal Monetary Stabilization Policy," Discussion Papers 0910-18, Columbia University, Department of Economics.
  3. Laura Coroneo & Valentina Corradi & Paulo Santos Monteiro, 2013. "Testing for optimal monetary policy via moment inequalities," Discussion Papers 13/07, Department of Economics, University of York.
  4. Davide Debortoli & Junior Maih & Ricardo Nunes, 2011. "Loose commitment in medium-scale macroeconomic models: theory and applications," International Finance Discussion Papers 1034, Board of Governors of the Federal Reserve System (U.S.).
  5. Davide Debortoli & Ricardo Nunes, 2011. "Monetary regime switches and unstable objectives," International Finance Discussion Papers 1036, Board of Governors of the Federal Reserve System (U.S.).

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