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Optimal Interest-Rate Rules: I. General Theory

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  • Marc P. Giannoni
  • Michael Woodford

Abstract

This paper proposes a general method for deriving an optimal monetary policy rule in the case of a dynamic linear rational-expectations model and a quadratic objective function for policy. A commitment to a rule of the type proposed results in a determinate equilibrium in which the responses to shocks are optimal. Furthermore, the optimality of the proposed policy rule is independent of the specification of the stochastic disturbances. Finally, the proposed rules can be justified from a timeless perspective,' so that commitment to such a rule need not imply time-inconsistent policy. We show that under fairly general condition, optimal policy can by represented by a generalized Taylor rule, in which however the relation between the interest-rate instrument and the other target variables is not purely contemporaneous, as in Taylor's specification. We also offer general conditions under which optimal policy can be represented by a 'super-inertial' interest-rate rule, and under which it can be represented by a pure 'targeting rule' that makes no explicit reference to the path of the instrument.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9419.

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Date of creation: Jan 2003
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Handle: RePEc:nbr:nberwo:9419

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  1. Nicoletta Batini & Joe Pearlman, 2002. "Too Much Too Soon: Instability and Indeterminacy with Forward-Looking Rules," Computing in Economics and Finance 2002, Society for Computational Economics 182, Society for Computational Economics.
  2. Rudebusch, Glenn D & Svensson, Lars E O, 1998. "Policy Rules for Inflation Targeting," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1999, C.E.P.R. Discussion Papers.
  3. Currie,David & Levine,Paul, 2009. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521104609.
  4. Andrew Levin & Volker Wieland & John C. Williams, 2003. "The Performance of Forecast-Based Monetary Policy Rules Under Model Uncertainty," American Economic Review, American Economic Association, American Economic Association, vol. 93(3), pages 622-645, June.
  5. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers, Bank of England 91, Bank of England.
  6. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  7. Marc P. Giannoni, 2007. "Robust optimal monetary policy in a forward-looking model with parameter and shock uncertainty," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 22(1), pages 179-213.
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