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Monetary Policy for Inattentive Economies

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Author Info
Laurence Ball
N. Gregory Mankiw
Ricardo Reis

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Abstract

This paper is a contribution to the analysis of optimal monetary policy. It begins with a critical assessment of the existing literature, arguing that most work is based on implausible models of inflation-output dynamics. It then suggests that this problem may be solved with some recent behavioral models, which assume that price setters are slow to incorporate macroeconomic information into the prices they set. A specific such model is developed and used to derive optimal policy. In response to shocks to productivity and aggregate demand, optimal policy is price level targeting. Base drift in the price level, which is implicit in the inflation targeting regimes currently used in many central banks, is not desirable in this model. When shocks to desired markups are added, optimal policy is flexible targeting of the price level. That is, the central bank should allow the price level to deviate from its target for a while in response to these supply shocks, but it should eventually return the price level to its target path. Optimal policy can also be described as an elastic price standard: the central bank allows the price level to deviate from its target when output is expected to deviate from its natural rate.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9491.

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Date of creation: Feb 2003
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Handle: RePEc:nbr:nberwo:9491

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E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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  1. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information Versus Sticky Prices: A Proposal To Replace The New Keynesian Phillips Curve," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1295-1328, November. [Downloadable!] (restricted)
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  2. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
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  3. Svensson, L-E-O, 1996. "Price Level Targeting vs Inflation Targeting : A free Lunch?," Papers 614, Stockholm - International Economic Studies.
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  4. Mankiw, N Gregory, 2001. "The Inexorable and Mysterious Tradeoff between Inflation and Unemployment," Economic Journal, Royal Economic Society, vol. 111(471), pages C45-61, May. [Downloadable!] (restricted)
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  5. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
  6. Alogoskoufis, George S & Smith, Ron, 1991. "The Phillips Curve, the Persistence of Inflation, and the Lucas Critique: Evidence from Exchange-Rate Regimes," American Economic Review, American Economic Association, vol. 81(5), pages 1254-75, December. [Downloadable!] (restricted)
  7. James Peery Cover & Paul Pecorino, 2005. "Price and Output Stability under Price-Level Targeting," Southern Economic Journal, Southern Economic Association, vol. 72(1), pages 152–166, July.
  8. Ball, Laurence, 1999. "Efficient Rules for Monetary Policy," International Finance, Blackwell Publishing, vol. 2(1), pages 63-83, April. [Downloadable!] (restricted)
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  9. Aoki, Kosuke, 2002. "Optimal Commitment Policy Under Noisy Information," CEPR Discussion Papers 3370, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  10. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden). [Downloadable!]
  11. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February. [Downloadable!] (restricted)
  12. Robert E. Hall, 1984. "Monetary strategy with an elastic price standard," Proceedings, Federal Reserve Bank of Kansas City, pages 137-167.
  13. Xavier Gabaix & David Laibson, 2002. "The 6D Bias and the Equity Premium Puzzle," Harvard Institute of Economic Research Working Papers 1947, Harvard - Institute of Economic Research. [Downloadable!]
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  14. Barsky, Robert B., 1987. "The Fisher hypothesis and the forecastability and persistence of inflation," Journal of Monetary Economics, Elsevier, vol. 19(1), pages 3-24, January. [Downloadable!] (restricted)
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  15. Laurence Ball, 2000. "Near-Rationality and Inflation in Two Monetary Regimes," NBER Working Papers 7988, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  16. Gordon, Robert J, 1996. "The Time-varying NAIRU and its Implications for Economic Policy," CEPR Discussion Papers 1492, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  17. Rotemberg, Julio J, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Blackwell Publishing, vol. 49(4), pages 517-31, October. [Downloadable!] (restricted)
  18. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April. [Downloadable!] (restricted)
  19. Staiger, Douglas & Stock, James H & Watson, Mark W, 1997. "The NAIRU, Unemployment and Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 33-49, Winter. [Downloadable!] (restricted)
  20. Robert E. Hall & N. Gregory Mankiw, 1994. "Nominal Income Targeting," NBER Chapters, in: Monetary Policy, pages 71-94 National Bureau of Economic Research, Inc. [Downloadable!]
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  21. Ball, Laurence & Mankiw, N Gregory, 1995. "Relative-Price Changes as Aggregate Supply Shocks," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 161-93, February. [Downloadable!] (restricted)
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  22. Richard Clarida & Jordi Gali & Mark Gertler, 2002. "A Simple Framework for International Monetary Policy Analysis," NBER Working Papers 8870, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  23. George A. Akerlof, 2002. "Behavioral Macroeconomics and Macroeconomic Behavior," American Economic Review, American Economic Association, vol. 92(3), pages 411-433, June. [Downloadable!]
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  24. Michael Woodford, 2001. "Imperfect Common Knowledge and the Effects of Monetary Policy," NBER Working Papers 8673, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  25. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond. [Downloadable!]
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  26. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February. [Downloadable!] (restricted)
  27. 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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