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The elusive welfare economics of price stability as a monetary policy objective - why New Keynesian central bankers should validate core inflation

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Author Info
Willem H. Buiter () (European Institute, London School of Economics, Houghton Street, London WC2A 2AE, United Kingdom.)

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Abstract

The paper studies the inflation rate associated with optimal monetary and fiscal policy in a number of standard dynamic stochastic general equilibrium models with nominal price rigidities. While the focus is on Calvo-style nominal price contracts with a range of indexation rules for constrained price setters, the conclusions have much wider validity - (1) Regardless of whether nominal price and/or wage rigidities are due to New-Keynesian, Old-Keynesian or sticky-information Phillips curves, optimal inflation policy requires the validation, that is, the full accommodation of core producer inflation by actual producer price inflation;(2) Optimal monetary policy implements Bailey-Friedman optimal quantity of money rule. No welfare-economics based argument for price stability as an objective (let alone the overriding objective) of monetary policy can be established for the class of DSGE models with nominal rigidities for which they have been proposed by Woodford and others. JEL Classification: E3; E4; E5; E6.

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Paper provided by European Central Bank in its series Working Paper Series with number 609.

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Length: 72 pages
Date of creation: Apr 2006
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Handle: RePEc:ecb:ecbwps:20060609

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Related research
Keywords: Inflation targeting; nominal price rigidities; New Keynesian macroeconomics; DSGE.;

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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.:
  1. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information Versus Sticky Prices: A Proposal To Replace The New Keynesian Phillips Curve," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1295-1328, November. [Downloadable!] (restricted)
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  2. Michael Woodford & Pierpaolo Benigno, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," 2004 Meeting Papers 481, Society for Economic Dynamics.
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  3. Willem H. Buiter, 2003. "Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap," NBER Working Papers 10163, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Ricardo Reis, 2004. "Inattentive Consumers," NBER Working Papers 10883, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359. [Downloadable!] (restricted)
  6. Goodhart, Charles A E, 2000. "Can Central Banking Survive the IT Revolution?," International Finance, Blackwell Publishing, vol. 3(2), pages 189-209, July. [Downloadable!] (restricted)
  7. Friedman, Benjamin M, 1999. "The Future of Monetary Policy: The Central Bank as an Army with Only a Signal Corps?," International Finance, Blackwell Publishing, vol. 2(3), pages 321-38, November. [Downloadable!] (restricted)
  8. Buiter, Willem H & Sibert, Anne, 2004. "Deflationary Bubbles," CEPR Discussion Papers 4528, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  9. Charles Goodhart, 2000. "Can Central Banking Survive the IT Revolution?," FMG Special Papers sp125, Financial Markets Group. [Downloadable!] (restricted)
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  11. Caplin, Andrew & Leahy, John, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 683-708, August. [Downloadable!] (restricted)
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  12. Willem H Buiter & Nikolaos Panigirtzoglou, . "Liquidity traps: how to avoid them and how to escape them," Bank of England working papers 111, Bank of England. [Downloadable!]
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  13. Willem H. Buiter, 2005. "New Developments in Monetary Economics: Two ghosts, Two Eccentricities, a Fallacy, a Mirage and a Mythos," Economic Journal, Royal Economic Society, vol. 115(502), pages C1-C31, 03. [Downloadable!] (restricted)
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  15. Phelps, Edmund S, 1969. "The New Microeconomics in Inflation and Employment Theory," American Economic Review, American Economic Association, vol. 59(2), pages 147-60, May. [Downloadable!] (restricted)
  16. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February. [Downloadable!] (restricted)
  17. Buiter, Willem H & Jewitt, Ian, 1981. "Staggered Wage Setting with Real Wage Relativities: Variations on a Theme of Taylor," The Manchester School of Economic & Social Studies, Blackwell Publishing, vol. 49(3), pages 211-28, September.
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  21. Edmund S. Phelps, 1968. "Money-Wage Dynamics and Labor-Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 76, pages 678. [Downloadable!] (restricted)
  22. Buiter, Willem H, 1985. "International Monetary Policy to Promote Economic Recovery," CEPR Discussion Papers 55, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  23. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1007-1057.
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  24. Costa Storti, Cláudia & De Grauwe, Paul, 2001. "Monetary Policy in a Cashless Society," CEPR Discussion Papers 2696, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  25. Smets, Frank & Wouters, Rafael, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," CEPR Discussion Papers 6112, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  26. Lars E.O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters, in: The Inflation-Targeting Debate, pages 19-92 National Bureau of Economic Research, Inc. [Downloadable!]
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  27. Svensson, Lars, 1999. "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," Seminar Papers 673, Stockholm University, Institute for International Economic Studies. [Downloadable!]
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  28. Willem H. Buiter & Nikolaos Panigirtzoglou, 2003. "Overcoming the zero bound on nominal interest rates with negative interest on currency: gesell's solution," Economic Journal, Royal Economic Society, vol. 113(490), pages 723-746, October. [Downloadable!] (restricted)
  29. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  30. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April. [Downloadable!] (restricted)
  31. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June. [Downloadable!] (restricted)
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  32. Willem H. Buiter, 2004. "The Elusive Welfare Economics of Price Stability as a Monetary Policy Objective: Should New Keynesian Central Bankers Pursue Price Stability?," NBER Working Papers 10848, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  33. Benjamin M. Friedman, 1999. "The Future of Monetary Policy: The Central Bank as an Army With Only a Signal Corps," NBER Working Papers 7420, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  34. Ball, Laurence & Gregory Mankiw, N. & Reis, Ricardo, 2005. "Monetary policy for inattentive economies," Journal of Monetary Economics, Elsevier, vol. 52(4), pages 703-725, May. [Downloadable!] (restricted)
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  35. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Oxford University Press, vol. 18(2), pages 203-20, April.
  36. Robert E. Hall, 1999. "Controlling the Price Level," NBER Working Papers 6914, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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Cited by:
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  1. W.H. Buiter, 2007. "Is Numérairology the Future of Monetary Economics?Unbundling numéraire and medium of exchange through a virtual currency and a shadow exchange rate," CEP Discussion Papers dp0776, Centre for Economic Performance, LSE. [Downloadable!]
    Other versions:
  2. Willem Buiter, 2007. "Is Numérairology the Future of Monetary Economics?," Open Economies Review, Springer, vol. 18(2), pages 127-156, April. [Downloadable!] (restricted)
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