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Opitmal Interest-Rate Rules: I. General Theory

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Author Info
Marc P. Giannoni
Michael Woodford

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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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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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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
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. Andrew Levin & Volker Wieland & John C. Williams, 2003. "The Performance of Forecast-Based Monetary Policy Rules under Model Uncertainty," CFS Working Paper Series 2003/06, Center for Financial Studies. [Downloadable!]
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  2. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  3. 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., vol. 22(1), pages 179-213. [Downloadable!]
  4. Nicoletta Batini & Joe Pearlman, 2002. "Too Much Too Soon: Instability and Indeterminacy with Forward-Looking Rules," Computing in Economics and Finance 2002 182, Society for Computational Economics. [Downloadable!]
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  5. Nicoletta Batini & Andrew G Haldane, . "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England. [Downloadable!]
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  6. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier. [Downloadable!] (restricted)
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