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Optimal Interest-Rate Rules: II. Applications

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Author Info
Marc P. Giannoni
Michael Woodford

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Abstract

In this paper we calculate robustly optimal monetary policy rules for several variants of a simple optimizing model of the monetary transmission mechanism with sticky prices and/or wages. We discuss representations of optimal policy both in terms of interest-rate feedback rules that generalize the well-known Taylor rule,' and in terms of commitment to a target criterion of the kind discussed in familiar proposals for flexible inflation targeting.' Optimal rules, however, require that policy be history-dependent in ways not contemplated by many well-known proposals. We furthermore find that a robustly optimal policy rule is almost inevitably an implicit rule, that requires the central bank to use a structural model to project the economy's evolution under the contemplated policy action. Finally, our numerical examples suggest that optimal rules do not place nearly as much weight on projections of inflation or output many quarters in the future as occurs under the current practice of inflation-forecast targeting central banks.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9420.

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Date of creation: Jan 2003
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Handle: RePEc:nbr:nberwo:9420

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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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  1. Bennett T. McCallum, 2001. "Should Monetary Policy Respond Strongly to Output Gaps?," American Economic Review, American Economic Association, vol. 91(2), pages 258-262, May. [Downloadable!] (restricted)
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  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  3. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen. [Downloadable!] (restricted)
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  4. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
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  5. 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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  6. Robert E. Hall, 1984. "Monetary strategy with an elastic price standard," Proceedings, Federal Reserve Bank of Kansas City, pages 137-167.
  7. Sbordone, Argia M., 2002. "Prices and unit labor costs: a new test of price stickiness," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 265-292, March. [Downloadable!] (restricted)
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  8. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December. [Downloadable!] (restricted)
  9. Lars E. O. Svensson, 1997. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October. [Downloadable!] (restricted)
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  11. Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series 1998-50, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  12. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Research series 200210, National Bank of Belgium. [Downloadable!]
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  13. 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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  14. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Jean Boivin & Marc Giannoni, 2002. "Has monetary policy become less powerful?," Staff Reports 144, Federal Reserve Bank of New York. [Downloadable!]
  16. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October. [Downloadable!] (restricted)
  17. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc. [Downloadable!]
  18. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12. [Downloadable!]
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  19. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October. [Downloadable!] (restricted)
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