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

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  • Peter Tillmann

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    (University of Giessen)

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    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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    Bibliographic Info

    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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    Related research

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

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    1. 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.
    2. Riboni, Alessandro & Ruge-Murcia, Francesco, 2010. "Monetary Policy by Committee : Consensus, Chairman Dominance or Simple Majority ?," Economics Papers from University Paris Dauphine 123456789/7683, Paris Dauphine University.
    3. Dennis, Richard & Söderström, Ulf, 2002. "How Important Is Precommitment for Monetary Policy?," Working Paper Series 139, Sveriges Riksbank (Central Bank of Sweden).
    4. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
    5. George A. Kahn, 2012. "The Taylor Rule and the Practice of Central Banking," Book Chapters, in: Evan F. Koenig & Robert Leeson & George A. Kahn (ed.), The Taylor Rule and the Transformation of Monetary Policy, chapter 3 Hoover Institution, Stanford University.
    6. Ibrahim Chowdhury & Mathias Hoffmann & Andreas Schabert, 2004. "Inflation Dynamics and the Cost Channel of Monetary Transmission," Money Macro and Finance (MMF) Research Group Conference 2004 18, Money Macro and Finance Research Group.
    7. Alberto F. Alesina & Andrea Stella, 2010. "The Politics of Monetary Policy," NBER Working Papers 15856, National Bureau of Economic Research, Inc.
    8. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
    9. Dennis, Richard, 2010. "How robustness can lower the cost of discretion," Journal of Monetary Economics, Elsevier, vol. 57(6), pages 653-667, September.
    10. 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.
    11. 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.
    12. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
    13. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
    14. 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.
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