Optimal monetary policy in a model with habit formation and explicit tax distortions

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Optimal monetary policy in a model with habit formation and explicit tax distortions

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Jeffrey C. Fuhrer

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Jeffrey C. Fuhrer

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. This paper is a revised version of Working Paper 00-5,"Optimal Monetary Policy in a Model with Habit Formation."

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Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number 01-06.

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Date of creation: 2001
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Handle: RePEc:fip:fedbwp:01-06

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Svensson, L-E-O, 1996. "Price Level Targeting vs Inflation Targeting : A free Lunch?," Papers 614, Stockholm - International Economic Studies.
Other versions:
- Lars E. O. Svensson, 1996. "Price Level Targeting vs. Inflation Targeting: A Free Lunch?," NBER Working Papers 5719, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
- Svensson, Lars E.O., 1997. "Price Level Targeting vs. Inflation Targeting: A Free Lunch?," Seminar Papers 614, Stockholm University, Institute for International Economic Studies. [Downloadable!]
Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June. [Downloadable!] (restricted)
Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
Other versions:
- Rudebusch, G.D. & Svensson, L.E.O., 1998. "Policy Rules for Inflation Targeting," Papers 637, Stockholm - International Economic Studies.
- Rudebusch, Glenn D & Svensson, Lars E O, 1998. "Policy Rules for Inflation Targeting," CEPR Discussion Papers 1999, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
- Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy Rules for Inflation Targeting," NBER Working Papers 6512, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
- Svensson, Lars E.O. & Rudebusch , Glenn, 1998. "Policy Rules for Inflation Targeting," Seminar Papers 637, Stockholm University, Institute for International Economic Studies. [Downloadable!]
- Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Working Papers in Applied Economic Theory and Econometrics 98-03, Federal Reserve Bank of San Francisco.
- Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters, in: Monetary Policy Rules, pages 203-262 National Bureau of Economic Research, Inc. [Downloadable!]
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)
Other versions:
- John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc. [Downloadable!]
Christina D. Romer & David H. Romer, 1997. "Reducing Inflation: Motivation and Strategy," NBER Books, National Bureau of Economic Research, Inc, number rome97-1, Summer.
Nicoletta Batini & Anthony Yates, . "Hybrid inflation and price level targeting," Bank of England working papers 135, Bank of England. [Downloadable!]
Other versions:
- Batini, Nicoletta & Yates, Anthony, 2003. " Hybrid Inflation and Price-Level Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(3), pages 283-300, June.
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)
Other versions:
- Svensson, Lars, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Seminar Papers 687, Stockholm University, Institute for International Economic Studies. [Downloadable!]
- Lars E.O. Svensson, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," NBER Working Papers 7957, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
- Svensson, Lars-E-O, 2001. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(S1), pages 277-312, February. [Downloadable!]
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)
Other versions:
- Bennett T. McCallum & Edward Nelson, . "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," GSIA Working Papers 1997-71, Carnegie Mellon University, Tepper School of Business.
- McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
Arturo Estrella & Jeffrey C. Fuhrer, 2002. "Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational-Expectations Models," American Economic Review, American Economic Association, vol. 92(4), pages 1013-1028, September. [Downloadable!]
Other versions:
- Arturo Extrella & Jeffrey C. Fuhrer, 1998. "Dynamic inconsistencies: counterfactual implications of a class of rational expectations models," Working Papers 98-5, Federal Reserve Bank of Boston. [Downloadable!]
Svensson, Lars E.O., 1997. "Inflation Targeting: Some Extensions," Seminar Papers 625, Stockholm University, Institute for International Economic Studies. [Downloadable!]
Other versions:
- Lars E. O. Svensson, 1999. "Inflation Targeting: Some Extensions," NBER Working Papers 5962, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
- Svensson, L-E-O, 1997. "Inflation Targeting : Some Extensions," Papers 625, Stockholm - International Economic Studies.
- Svensson, Lars E O, 1999. " Inflation Targeting: Some Extensions," Scandinavian Journal of Economics, Blackwell Publishing, vol. 101(3), pages 337-61, September. [Downloadable!] (restricted)
Martin S. Feldstein, 1997. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 123-166 National Bureau of Economic Research, Inc. [Downloadable!]
Other versions:
- 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)
Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February. [Downloadable!] (restricted)
Other versions:
- Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Finance and Economics Discussion Series 93-17, Board of Governors of the Federal Reserve System (U.S.).
- Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
- Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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!]
Other versions:
- Tetlow, Robert J. & von zur Muehlen, Peter, 2001. "Simplicity versus optimality: The choice of monetary policy rules when agents must learn," Journal of Economic Dynamics and Control, Elsevier, vol. 25(1-2), pages 245-279, January. [Downloadable!] (restricted)
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.
Other versions:
- Alexander L. Wolman, 2003. "Real implications of the zero bound on nominal interest rates," Working Paper 03-15, Federal Reserve Bank of Richmond. [Downloadable!]
- Alexander L. Wolman, 1999. "Real Implications of the Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 1999 1152, Society for Computational Economics. [Downloadable!]
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!]
Other versions:
- John C. Williams, 2003. "Simple rules for monetary policy," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12. [Downloadable!]

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