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Optimal Target Criteria for Stabilization Policy

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  • Marc P. Giannoni
  • Michael Woodford

Abstract

This paper considers a general class of nonlinear rational-expectations models in which policymakers seek to maximize an objective function that may be household expected utility. We show how to derive a target criterion that is: (i) consistent with the model's structural equations, (ii) strong enough to imply a unique equilibrium, and (iii) optimal, in the sense that a commitment to adjust the policy instrument at all dates so as to satisfy the target criterion maximizes the objective function. The proposed optimal target criterion is a linear equation that must be satisfied by the projected paths of certain economically relevant "target variables". It takes the same form at all times and generally involves only a small number of target variables, regardless of the size and complexity of the model. While the projected path of the economy requires information about the current state, the target criterion itself can be stated without reference to a complete description of the state of the world. We illustrate the application of the method to a nonlinear DSGE model with staggered price-setting, in which the objective of policy is to maximize household expected utility.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15757.

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Date of creation: Feb 2010
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Handle: RePEc:nbr:nberwo:15757

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References

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  1. Michael Woodford & Pierpaolo Benigno, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," 2004 Meeting Papers 481, Society for Economic Dynamics.
  2. Benigno, Pierpaolo & Woodford, Michael, 2012. "Linear-quadratic approximation of optimal policy problems," Journal of Economic Theory, Elsevier, Elsevier, vol. 147(1), pages 1-42.
  3. Currie,David & Levine,Paul, 1993. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521441964.
  4. M. H. Khalil Timamy, 2005. "Debate," Review of African Political Economy, Taylor & Francis Journals, vol. 32(104-105), pages 383-393, June.
  5. Michael Woodford, 2012. "Forecast Targeting as a Monetary Policy Strategy - Policy Rules in Practice," Book Chapters, Hoover Institution, Stanford University, in: Evan F. Koenig & Robert Leeson & George A. Kahn (ed.), The Taylor Rule and the Transformation of Monetary Policy, chapter 9 Hoover Institution, Stanford University.
  6. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," NBER Working Papers 9419, National Bureau of Economic Research, Inc.
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Cited by:
  1. Reis, Ricardo, 2013. "Central Bank Design," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9567, C.E.P.R. Discussion Papers.
  2. Yuriy Gorodnichenko & Johannes Wieland & Olivier Coibion, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," 2012 Meeting Papers, Society for Economic Dynamics 70, Society for Economic Dynamics.
  3. Laura Coroneo & Valentina Corradi & Paulo Santos Monteiro, 2013. "Testing for optimal monetary policy via moment inequalities," Discussion Papers, Department of Economics, University of York 13/07, Department of Economics, University of York.
  4. Davide Debortoli & Junior Maih & Ricardo Nunes, 2011. "Loose commitment in medium-scale macroeconomic models: theory and applications," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 1034, Board of Governors of the Federal Reserve System (U.S.).
  5. Michael Woodford, 2012. "Principled Policymaking in an Uncertain World," INET Research Notes 10, Institute for New Economic Thinking (INET).
  6. Laséen, Stefan & Svensson, Lars E.O., 2011. "Anticipated Alternative Policy-Rate Paths in Policy Simulations," Working Paper Series 248, Sveriges Riksbank (Central Bank of Sweden).
  7. Olivier Loisel, 2013. "The Implementation of Stabilization Policy," Working Papers, Centre de Recherche en Economie et Statistique 2013-24, Centre de Recherche en Economie et Statistique.
  8. Adam, Klaus & Woodford, Michael, 2012. "Robustly Optimal Monetary Policy in a Microfounded New Keynesian Model," Working Papers, University of Mannheim, Department of Economics 12-01, University of Mannheim, Department of Economics.
  9. Marc P. Giannoni, 2010. "Optimal Interest-Rate Rules in a Forward-Looking Model, and Inflation Stabilization versus Price-Level Stabilization," NBER Working Papers 15986, National Bureau of Economic Research, Inc.
  10. Michael Woodford, 2010. "Optimal Monetary Stabilization Policy," NBER Working Papers 16095, National Bureau of Economic Research, Inc.
  11. Davide Debortoli & Ricardo Nunes, 2011. "Monetary regime switches and unstable objectives," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 1036, Board of Governors of the Federal Reserve System (U.S.).
  12. Marc P. Giannoni, 2012. "Optimal interest rate rules and inflation stabilization versus price-level stabilization," Staff Reports, Federal Reserve Bank of New York 546, Federal Reserve Bank of New York.
  13. Lars E.O. Svensson, 2010. "Inflation Targeting," NBER Working Papers 16654, National Bureau of Economic Research, Inc.

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