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The Optimality and Controllability of Monetary Policy through Delegation with Consistent Targets

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Author Info

  • Huiping Yuan

    ()
    (Department of Finance, Xiamen University)

  • Stephen M. Miller

    ()
    (Department of Economics, University of Nevada, Las Vegas)

  • Langnan Chen

    ()
    (Institute for Economics, Sun Yat-sen University)

Abstract

This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. Control theory can identify the optimal plan and, thus, the optimal economic outcomes. Then, we can seek a consistent plan that coincides with the optimal plan through institutional design. That is, the optimal plan can indicate how to design the optimal institution, through which we implement the optimal plan with a consistent plan.

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File URL: http://web.unlv.edu/projects/RePEc/pdf/0909.pdf
File Function: First version, 2008
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Bibliographic Info

Paper provided by University of Nevada, Las Vegas , Department of Economics in its series Working Papers with number 0909.

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Length: 35 pages
Date of creation: Mar 2009
Date of revision:
Publication status: Published in Scottish Journal of Political Economy
Handle: RePEc:nlv:wpaper:0909

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Keywords: Optimal policy; Consistent policy; Institutional design;

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References

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  1. David M Kreps & Robert Wilson, 2003. "Sequential Equilibria," Levine's Working Paper Archive 618897000000000813, David K. Levine.
  2. Huiping Yuan & Stephen M. Miller, 2010. "Designing Central Bank Loss Functions," International Journal of Business and Economics, College of Business, and College of Finance, Feng Chia University, Taichung, Taiwan, vol. 9(1), pages 77-81, April.
  3. David Backus & John Driffill, 1984. "Inflation and Reputation," Working Papers 560, Queen's University, Department of Economics.
  4. Svensson, L.E.O., 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," Papers 595, Stockholm - International Economic Studies.
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  8. Calvo, Guillermo A, 1978. "On the Time Consistency of Optimal Policy in a Monetary Economy," Econometrica, Econometric Society, vol. 46(6), pages 1411-28, November.
  9. Rodriguez, Alvaro, 1981. "Rawls' Maximin Criterion and Time Consistency: A Generalization," Review of Economic Studies, Wiley Blackwell, vol. 48(4), pages 599-605, October.
  10. V. V. Chari & Patrick J Kehoe, 1998. "Sustainable Plans," Levine's Working Paper Archive 600, David K. Levine.
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  12. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  13. Huiping Yuan & Stephen M. Miller, 2009. "The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy," Working Papers 0910, University of Nevada, Las Vegas , Department of Economics.
  14. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  15. Stephen M. Miller & Huiping Yuan, 2005. "Consistent Targets and Optimal Monetary Policy: Conservative Central Banker Redux," Working papers 2005-55, University of Connecticut, Department of Economics, revised Jan 2009.
  16. Pollak, Robert A, 1979. "Bergson-Samuelson Social Welfare Functions and the Theory of Social Choice," The Quarterly Journal of Economics, MIT Press, vol. 93(1), pages 73-90, February.
  17. Dasgupta, Partha, 1974. "On some alternative criteria for justice between generations," Journal of Public Economics, Elsevier, vol. 3(4), pages 405-423, November.
  18. Persson, Torsten & Tabellini, Guido, 1993. "Designing institutions for monetary stability," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 53-84, December.
  19. Calvo, Guillermo A, 1978. "Some Notes on Time Inconsistency and Rawls' Maximin Criterion," Review of Economic Studies, Wiley Blackwell, vol. 45(1), pages 97-102, February.
  20. Georgios E. Chortareas & Stephen M. Miller, 2003. "Monetary Policy Delegation, Contract Costs and Contract Targets," Bulletin of Economic Research, Wiley Blackwell, vol. 55(1), pages 101-112, January.
  21. V.V. Chari, 1988. "Time consistency and optimal policy design," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 17-31.
  22. Kydland, Finn, 1977. "Equilibrium solutions in dynamic dominant-player models," Journal of Economic Theory, Elsevier, vol. 15(2), pages 307-324, August.
  23. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 173-203, January.
  24. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  25. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  26. Leininger, Wolfgang, 1985. "Rawls' Maximin Criterion and Time-Consistency: Further Results," Review of Economic Studies, Wiley Blackwell, vol. 52(3), pages 505-13, July.
  27. 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.
  28. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
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Cited by:
  1. Stephen M. Miller & Huiping Yuan, 2005. "Consistent Targets and Optimal Monetary Policy: Conservative Central Banker Redux," Working papers 2005-55, University of Connecticut, Department of Economics, revised Jan 2009.
  2. Huiping Yuan & Stephen M. Miller, 2011. "The Optimality and Controllability of Discretionary Monetary Policy," Working papers 2011-17, University of Connecticut, Department of Economics.
  3. Huiping Yuan & Stephen M. Miller, 2006. "The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy," Working papers 2006-06, University of Connecticut, Department of Economics, revised Jan 2009.

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