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Optimal monetary policy in a model with habit formation

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Author Info
Jeffrey C. Fuhrer

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Abstract

A number of recent papers have explored monetary policy options, including inflation targeting and inflation forecast targeting (notably Svensson (1999a, 1999b, 2000)) and price level targeting (Wolman 2000, Batini and Yates 1999, Blinder 1999). Most papers explore "optimal" monetary policy in the context of a single model. However, a number of conclusions made in the literature depend strongly on the model specification used. In addition, most papers have used the efficient policy frontier concept to define optimal monetary policy. This paper investigates the behavior of a variety of small structural macro models under a variety of targeting rules. The paper examines both minimum variance policy frontiers and utility-maximizing policy. In the latter case, an explicit model of consumer behavior with inflation-induced tax distortions is explored. The paper examines the improvement in utility from an optimal price-level target and re-examines the improvement in utility in moving from a positive to a zero target inflation rate.

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Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number 00-5.

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Date of creation: 2000
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Handle: RePEc:fip:fedbwp:00-5

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Keywords: Monetary policy Interest rates Consumer behavior

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This paper has been announced in the following NEP Reports: 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. Svensson, L-E-O, 1996. "Price Level Targeting vs Inflation Targeting : A free Lunch?," Papers 614, Stockholm - International Economic Studies.
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  2. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  3. John Y. Campbell & N. Gregory Mankiw, 1990. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Nicoletta Batini & Anthony Yates, . "Hybrid inflation and price level targeting," Bank of England working papers 135, Bank of England. [Downloadable!]
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  5. Svensson, Lars E O, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," CEPR Discussion Papers 2566, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  6. Bennett T. McCallum & Edward Nelson, 2000. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," NBER Working Papers 5875, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Svensson, Lars E.O., 1997. "Inflation Targeting: Some Extensions," Seminar Papers 625, Stockholm University, Institute for International Economic Studies. [Downloadable!]
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  8. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February. [Downloadable!] (restricted)
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  9. Robert J. Tetlow & Peter von zur Muehlen, 1999. "Simplicity versus optimality the choice of monetary policy rules when agents must learn," Finance and Economics Discussion Series 1999-10, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  10. repec:fth:harver:1435 is not listed on IDEAS
  11. Wolman, Alexander L, 2005. "Real Implications of the Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 273-96, April.
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  12. Martin Feldstein, 1997. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Working Papers 5469, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Fuhrer, Jeffrey C & Moore, George R, 1995. "Monetary Policy Trade-offs and the Correlation between Nominal Interest Rates and Real Output," American Economic Review, American Economic Association, vol. 85(1), pages 219-39, March.
  14. John C. Williams, 1999. "Simple rules for monetary policy," Finance and Economics Discussion Series 1999-12, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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(explanations, 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. Frank Smets & Raf Wouters, 2004. "Comparing shocks and frictions in US and euro area business cycles: a Bayesian DSGE approach," Research series 200410-1, National Bank of Belgium. [Downloadable!]
    Other versions:
  2. Caraiani, Petre, 2007. "An Estimated New Keynesian Model for Romania," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 4(4), pages 114-123, December. [Downloadable!]
  3. Jean-Paul Lam & Greg Tkacz, 2004. "Estimating Policy-Neutral Interest Rates for Canada Using a Dynamic Stochastic General Equilibrium Framework," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 127(I), pages 89-126, March. [Downloadable!]
    Other versions:
  4. Urban Jermann, 2002. "EconomicDynamics Interviews Urban Jermann on Asset Pricing," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 3(2), April. [Downloadable!]
  5. Richard Dennis, 2006. "The frequency of price adjustment and New Keynesian business cycle dynamics," Working Paper Series 2006-22, Federal Reserve Bank of San Francisco. [Downloadable!]
  6. Frank Smets & Rafael Wouters, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 171, European Central Bank. [Downloadable!]
  7. 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, issue Mar. [Downloadable!]
  8. Minford, Patrick & Sofat, Prakriti & Nowell, Eric & Srinivasan, Naveen, 2005. "UK Inflation Persistence: Policy or Nature?," Cardiff Economics Working Papers E2005/1, Cardiff University, Cardiff Business School, Economics Section. [Downloadable!]
    Other versions:
  9. Richard Dennis, 2004. "Specifying and estimating New Keynesian models with instrument rules and optimal monetary policies," Working Papers in Applied Economic Theory 2004-17, Federal Reserve Bank of San Francisco. [Downloadable!]
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