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Cross-Checking Optimal Monetary Policy with Information from the Taylor Rule

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  • Peter Tillmann

    ()
    (University of Giessen)

Abstract

This paper shows that monetary policy should be delegated to a central bank that cross-checks optimal policy with information from the Taylor rule. Attaching some weight to deviations of the interest rate from the interest rate prescribed by the Taylor rule is beneficial if the central bank aims at optimally stabilizing inflation and output gap variability under discretion. Placing a weight on deviations from a simple Taylor rule increases the overall relative weight of inflation volatility in the effective loss function, which reduces the stabilization bias of discretionary monetary policy. The welfare-enhancing role of this modified loss function depends on the size of the stabilization bias, i.e. on the degree of persistence in the cost-push shock process, and the relevance of demand shocks. These results can be interpreted in terms of the optimal composition of monetary policy committees.

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File URL: http://www.uni-marburg.de/fb02/makro/forschung/magkspapers/32-2011_tillmann.pdf
File Function: First version, 2011
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Paper provided by Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung) in its series MAGKS Papers on Economics with number 201132.

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Length: 22 pages
Date of creation: 2011
Date of revision:
Publication status: Forthcoming in
Handle: RePEc:mar:magkse:201132

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Keywords: optimal monetary policy; stabilization bias; monetary policy delegation; robustness; Taylor rule; monetary policy committee;

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  1. Alberto F. Alesina & Andrea Stella, 2010. "The Politics of Monetary Policy," NBER Working Papers 15856, National Bureau of Economic Research, Inc.
  2. Alessandro Riboni & Francisco J. Ruge-Murcia, 2010. "Monetary Policy by Committee: Consensus, Chairman Dominance, or Simple Majority?," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 363-416, February.
  3. Dennis, Richard, 2010. "How robustness can lower the cost of discretion," Journal of Monetary Economics, Elsevier, vol. 57(6), pages 653-667, September.
  4. Richard Dennis & Ulf Soderstrom, 2002. "How important is precommitment for monetary policy?," Working Paper Series 2002-10, Federal Reserve Bank of San Francisco.
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  8. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
  9. Taylor, John B. & Williams, John C., 2010. "Simple and Robust Rules for Monetary Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 15, pages 829-859 Elsevier.
  10. Christian Jensen & Bennett C. McCallum, 2002. "The Non-Optimality of Proposed Monetary Policy Rules Under Timeless-Perspective Commitment," NBER Working Papers 8882, National Bureau of Economic Research, Inc.
  11. Carl E. Walsh, 2010. "Monetary Theory and Policy, Third Edition," MIT Press Books, The MIT Press, edition 3, volume 1, number 0262013770, December.
  12. Paez-Farrell, Juan, 2012. "Should central bankers discount the future? A note," Economics Letters, Elsevier, vol. 114(1), pages 20-22.
  13. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  14. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
  15. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  16. Juha Kilponen & Kai Leitemo, 2008. "Model Uncertainty and Delegation: A Case for Friedman's "k"-Percent Money Growth Rule?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(2-3), pages 547-556, 03.
  17. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
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