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Optimal Operational Monetary Policy in the Christiano-Eichenbaum-Evans Model of the U.S. Business Cycle

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Author Info
Stephanie Schmitt-Grohe
Martin Uribe

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Abstract

This paper identifies optimal interest-rate rules within a rich, dynamic, general equilibrium model that has been shown to account well for observed aggregate dynamics in the postwar United States. We perform policy evaluations based on second-order accurate approximations to conditional and unconditional expected welfare. We require that interest-rate rules be operational, in the sense that they include as arguments only a few readily observable macroeconomic indicators and respect the zero bound on nominal interest rates. We find that the optimal operational monetary policy is a real-interest-rate targeting rule. That is, an interest-rate feedback rule featuring a unit inflation coefficient, a mute response to output, and no interest-rate smoothing. Contrary to existing studies, we find a significant degree of optimal inflation volatility. A key factor driving this result is the assumption of indexation to past inflation. Under indexation to long-run inflation the optimal inflation volatility is close to zero. Finally, we show that initial conditions matter for welfare rankings of policies.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10724.

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Date of creation: Sep 2004
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Handle: RePEc:nbr:nberwo:10724

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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References listed on IDEAS
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  18. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January. [Downloadable!] (restricted)
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  22. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under imperfect competition," Journal of Macroeconomics, Elsevier, vol. 26(2), pages 183-209, June. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Ester Faia, 2009. "Oligopolistic Competition and Optimal Monetary Policy," Kiel Working Papers 1552, Kiel Institute for the World Economy. [Downloadable!]
  2. Anton Nakov, 2008. "Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate," International Journal of Central Banking, International Journal of Central Banking, vol. 4(2), pages 73-127, June. [Downloadable!]
    Other versions:
  3. Sala, Luca & Söderström, Ulf & Trigari, Antonella, 2008. "Monetary Policy Under Uncertainty in an Estimated Model with Labour Market Frictions," CEPR Discussion Papers 6826, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  4. Matthieu Darracq Pariès & Stéphane Adjemian & Stéphane Moyen, 2007. "Optimal monetary policy in an estimated DSGE for the euro area," Working Paper Series 803, European Central Bank. [Downloadable!]
  5. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Working Papers 11523, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. Ludger Linnemann & Andreas Schabert, 2005. "Productive Government Expenditure in Monetary Business Cycle Models," Tinbergen Institute Discussion Papers 05-053/2, Tinbergen Institute. [Downloadable!]
    Other versions:
  7. Pablo A. Guerron, 2007. "The Welfare Costs of Inflation in a Micro-Founded Macroeconometric Model," Working Paper Series 013, North Carolina State University, Department of Economics. [Downloadable!]
  8. Stephanie Schmitt-Grohe & Martin Uribe, 2005. "Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model: Expanded Version," NBER Working Papers 11417, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Federico di Pace, 2008. "Revisiting the Comovement Puzzle: the Input-Output Structure as an Additional Solution," Birkbeck Working Papers in Economics and Finance 0807, Birkbeck, Department of Economics, Mathematics & Statistics. [Downloadable!]
  10. Eric Jondeau & Jean-Guillaume Sahuc, 2008. "Optimal Monetary Policy in an Estimated DSGE Model of the Euro Area with Cross-Country Heterogeneity," International Journal of Central Banking, International Journal of Central Banking, vol. 4(2), pages 23-72, June. [Downloadable!]
    Other versions:
  11. Pablo A. Guerron, 2007. "What You Match Does Matter: The Effects of Data on DSGE Estimation," Working Paper Series 012, North Carolina State University, Department of Economics. [Downloadable!]
  12. Di Bartolomeo, Giovanni & Manzo, Marco, 2007. "Do tax distortions lead to more indeterminacy? A New Keynesian perspective," MPRA Paper 3549, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  13. Andrea Colciago, 2006. "Sticky wages and rule of thumb consumers," Working Papers 98, University of Milano-Bicocca, Department of Economics, revised Sep 2006. [Downloadable!]
  14. Ester Faia, 2007. "Ramsey monetary policy with labour market frictions," Working Paper Series 707, European Central Bank. [Downloadable!]
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  15. Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Working Papers 050608, University of California-Irvine, Department of Economics. [Downloadable!]
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  16. Guido Ascari & Tiziano Ropele, 2009. "Trend inflation, Taylor principle and indeterminacy," Temi di discussione (Economic working papers) 708, Bank of Italy, Economic Research Department. [Downloadable!]
    Other versions:
  17. Ester Faia & Tommaso Monacelli, 2005. "Optimal Monetary Policy Rules, Asset Prices and Credit Frictions," Working Papers 279, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University. [Downloadable!]
    Other versions:
  18. Ester Faia, 2006. "Optimal monetary policy rules with labor market frictions," Working Paper Series 698, European Central Bank. [Downloadable!]
    Other versions:
  19. Niels Arne Dam & Jesper Gregers Linaa, 2005. "Assessing the Welfare Cost of a Fixed Exchange-Rate Policy," EPRU Working Paper Series 05-04, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics. [Downloadable!]
  20. Pablo A. Guerron, 2006. "Non-Separability, Heterogeneous Labor Supply, Investment, and the Business Cycle," Working Paper Series 005, North Carolina State University, Department of Economics, revised Aug 2006. [Downloadable!]
  21. Tommaso Monacelli & Ester Faia, 2005. "Optimal Interest Rate Rules, Asset Prices and Credit Frictions," Computing in Economics and Finance 2005 452, Society for Computational Economics. [Downloadable!]
    Other versions:
  22. Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal fiscal and monetary policy in a medium-scale macroeconomic model," Working Paper Series 612, European Central Bank. [Downloadable!]
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