Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two sets of frictions -- costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods -- we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible. In our benchmark model, there is some tendency for the monetary authority to smooth nominal and real interest rates.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Publisher Info
Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
9402.
Length: Date of creation: Dec 2002 Date of revision: Handle: RePEc:nbr:nberwo:9402
Note: EFG Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A. Phone: 617-868-3900 Email: Web page: http://www.nber.org More information through EDIRC
For technical questions regarding this item, or to correct its listing, contact: ().
Related research
Keywords:
Other versions of this item:
Article
Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003.
"Optimal Monetary Policy,"
Review of Economic Studies,
Blackwell Publishing, vol. 70(4), pages 825-860, October.
[Downloadable!] (restricted)
Paper
Aubhik Khan & Robert King & Alexander L. Wolman, 2002.
"Optimal monetary policy,"
Working Papers
02-19, Federal Reserve Bank of Philadelphia.
[Downloadable!]
Aubhik Khan & Robert G. King & Alexander L. Wolman, 2000.
"Optimal monetary policy,"
Working Paper
00-10, Federal Reserve Bank of Richmond.
[Downloadable!]
Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001.
"Optimal monetary policy,"
Working Papers
01-5, Federal Reserve Bank of Philadelphia.
[Downloadable!]
Find related papers by JEL classification: E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
This item is featured on the following reading lists:
References listed on IDEAS 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.:
Adao, Bernardino & Correia, Maria Isabel Horta & Teles, Pedro, 2001.
"Gaps and Triangles,"
CEPR Discussion Papers
2668, C.E.P.R. Discussion Papers.
[Downloadable!] (restricted)
Other versions:
Bernardino Adão & Isabel Correia & Pedro Teles, 2001.
"Gaps and triangles,"
Working Paper Series
WP-01-13, Federal Reserve Bank of Chicago.
[Downloadable!]
Chari, V.V. & Kehoe, Patrick J., 1999.
"Optimal fiscal and monetary policy,"
Handbook of Macroeconomics,
in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 26, pages 1671-1745
Elsevier.
[Downloadable!] (restricted)
Albert Marcet & Ramon Marimon, 1994.
"Recursive Contracts,"
Economics Working Papers
337, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 1998.
[Downloadable!]
Other versions:
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.) This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.