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Optimal Interest Rate Stabilization in a Basic Sticky-Price Model

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  • Matthias Paustian
  • Christian Stoltenberg

Abstract

This paper studies optimal monetary policy with the nominal interest rate as the single policy instrument in an economy, where firms set prices in a staggered way without indexation and real money balances contribute separately to households' utility. The optimal deterministic steady state under commitment is the Friedman rule - even if the importance assigned to the utility of money is small relative to consumption and leisure. We approximate the model around the optimal steady state as the long-run policy target. Optimal monetary policy is characterized by stabilization of the nominal interest rate instead of inflation stabilization as the predominant principle.

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Bibliographic Info

Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2006-072.

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Length: 53 pages
Date of creation: Oct 2006
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2006-072

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Keywords: Optimal monetary policy; commitment; timeless perspective; optimal steady state; staggered price setting; monetary friction; Friedman's rule;

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References

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  1. Bernardino Adão & Isabel Horta Correia & Pedro Teles, 2001. "Gaps and Triangles," Working Papers w200102, Banco de Portugal, Economics and Research Department.
  2. Ascari, Guido, 2003. "Staggered prices and trend inflation: some nuisances," Research Discussion Papers 27/2003, Bank of Finland.
  3. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "Optimal monetary policy," Working Papers 01-5, Federal Reserve Bank of Philadelphia.
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  8. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
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  10. Peter N. Ireland, 1999. "A method for taking models to the data," Working Paper 9903, Federal Reserve Bank of Cleveland.
  11. Walsh, Carl E., 2005. "Parameter misspecification and robust monetary policy rules," Working Paper Series 0477, European Central Bank.
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  14. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  15. Charles T. Carlstrom & Timothy S. Fuerst, 2004. "Thinking about Monetary Policy without Money," International Finance, Wiley Blackwell, vol. 7(2), pages 325-347, 07.
  16. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," NBER Working Papers 10838, National Bureau of Economic Research, Inc.
  17. Robert G. King & Alexander L. Wolman, 1996. "Inflation Targeting in a St. Louis Model of the 21st Century," NBER Working Papers 5507, National Bureau of Economic Research, Inc.
  18. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
  19. Javier Andrés & J. David López-Salido & Javier Vallés, 2006. "Money in an Estimated Business Cycle Model of the Euro Area," Economic Journal, Royal Economic Society, vol. 116(511), pages 457-477, 04.
  20. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, December.
  21. Alexander L. Wolman, 2001. "A primer on optimal monetary policy with staggered price-setting," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 27-52.
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Cited by:
  1. Airaudo, Marco & Cardani, Roberta & Lansing, Kevin J., 2013. "Monetary policy and asset prices with belief-driven fluctuations," Journal of Economic Dynamics and Control, Elsevier, vol. 37(8), pages 1453-1478.

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