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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. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
  2. Pierpaolo Benigno & Michael Woodford, 2006. "Linear-Quadratic Approximation of Optimal Policy Problems," NBER Working Papers 12672, National Bureau of Economic Research, Inc.
  3. Michael Woodford, 2007. "Forecast Targeting as a Monetary Policy Strategy: Policy Rules in Practice," NBER Working Papers 13716, National Bureau of Economic Research, Inc.
  4. Pierpaolo Benigno & Michael Woodford, 2005. "Inflation Stabilization And Welfare: The Case Of A Distorted Steady State," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1185-1236, December.
  5. M. H. Khalil Timamy, 2005. "Debate," Review of African Political Economy, Taylor & Francis Journals, vol. 32(104-105), pages 383-393, June.
  6. Currie,David & Levine,Paul, 1993. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521441964, October.
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Cited by:
  1. Davide Debortoli & Junior Maih & Ricardo Nunes, 2011. "Loose commitment in medium-scale macroeconomic models: theory and applications," International Finance Discussion Papers 1034, Board of Governors of the Federal Reserve System (U.S.).
  2. Laura Coroneo & Valentina Corradi & Paulo Santos Monteiro, 2013. "Testing for optimal monetary policy via moment inequalities," Discussion Papers 13/07, Department of Economics, University of York.
  3. 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 70, Society for Economic Dynamics.
  4. Michael Woodford, 2010. "Optimal Monetary Stabilization Policy," Discussion Papers 0910-18, Columbia University, Department of Economics.
  5. Stefan Laséen & Lars E.O. Svensson, 2011. "Anticipated Alternative policy Rate Paths in Plicy Simulations," International Journal of Central Banking, International Journal of Central Banking, vol. 7(3), pages 1-35, September.
  6. Marc P. Giannoni, 2012. "Optimal interest rate rules and inflation stabilization versus price-level stabilization," Staff Reports 546, Federal Reserve Bank of New York.
  7. Reis, Ricardo, 2013. "Central Bank Design," CEPR Discussion Papers 9567, C.E.P.R. Discussion Papers.
  8. Lars E.O. Svensson, 2010. "Inflation Targeting," NBER Working Papers 16654, National Bureau of Economic Research, Inc.
  9. Adam, Klaus & Woodford, Michael, 2012. "Robustly Optimal Monetary Policy in a Microfounded New Keynesian Model," Working Papers 12-01, University of Mannheim, Department of Economics.
  10. Michael Woodford, 2012. "Principled Policymaking in an Uncertain World," INET Research Notes 10, Institute for New Economic Thinking (INET).
  11. Davide Debortoli & Ricardo Nunes, 2011. "Monetary regime switches and unstable objectives," International Finance Discussion Papers 1036, Board of Governors of the Federal Reserve System (U.S.).
  12. Olivier Loisel, 2013. "The Implementation of Stabilization Policy," Working Papers 2013-24, Centre de Recherche en Economie et Statistique.
  13. Giannoni, Marc P., 2014. "Optimal interest-rate rules and inflation stabilization versus price-level stabilization," Journal of Economic Dynamics and Control, Elsevier, vol. 41(C), pages 110-129.
  14. 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.

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