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Optimal Policy and the Sectoral Composition of Output in a New Keynesian Model

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  • Vahagn Galstyan

    ()
    (Institute for International Integration Studies, Trinity College Dublin)

  • Michael Wycherley

    ()
    (Institute for International Integration Studies, Trinity College Dublin)

Abstract

The standard New Keynesian model allows the derivation of optimal monetary policy on the assumption that the economy is composed of a single sector. This paper analyses optimal policy on the basis that the economy comprises a number of different sectors. It shows that the composition of output matters, that policy should take into account the source of shocks as well as well as their aggregate magnitude, and that policy tools impacting individual sectors can be welfare improving. If sectoral policy is not adopted, then commitment in tax policy is important in similar ways and for similar reasons to commitment in monetary policy. With sectoral policy, commitment for tax and monetary policies ceases to be important.

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Bibliographic Info

Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp394.

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Length: 25 pages
Date of creation: Mar 2012
Date of revision:
Handle: RePEc:iis:dispap:iiisdp394

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Keywords: Tax policy; Monetary Policy; Multi-sector model; Welfare;

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References

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  1. Giovanni Dell'Ariccia & Olivier J. Blanchard & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," IMF Staff Position Notes 2010/03, International Monetary Fund.
  2. Charles T. Carlstrom & Timothy S. Fuerst & Fabio Ghironi, 2002. "Does It Matter (for Equilibrium Determinacy) What Price Index the Central Bank Targets?," Boston College Working Papers in Economics 533, Boston College Department of Economics, revised 07 Feb 2003.
  3. Emi Nakamura & Jón Steinsson, 2008. "Monetary Non-Neutrality in a Multi-Sector Menu Cost Model," NBER Working Papers 14001, National Bureau of Economic Research, Inc.
  4. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  5. Mark Bils & Peter J. Klenow, 2002. "Some Evidence on the Importance of Sticky Prices," NBER Working Papers 9069, National Bureau of Economic Research, Inc.
  6. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
  7. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  8. Erceg, Christopher & Levin, Andrew, 2006. "Optimal monetary policy with durable consumption goods," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1341-1359, October.
  9. Carlos Carvalho, 2005. "Heterogeneity in Price Setting and the Real Effects of Monetary Shocks," Macroeconomics 0509017, EconWPA, revised 12 Sep 2005.
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