Optimal Monetary Policy with Endogenous Capital Accumulation
AbstractThe previous literature on optimal monetary policy has focused mainly on dynamic stochastic general equilibrium models with a constant aggregate capital stock (cf. Woodford 1999; Erceg et al. 2000). In this paper, we analyze the monetary policy implications of endogenous capital accumulation. We augment the benchmark New Keynesian model to incorporate investment with quadratic adjustment costs, and use a perturbation algorithm to obtain the second-order approximation of the model around its steady state. Using these methods, we characterize the properties of the fully-optimal Ramsey policy under commitment, and compare the welfare implications of simple Taylor-style rules involving the inflation rate and the output gap. Simple rules in this class can be formulated in terms of two alternative definitions of potential output: the level that would prevail under flexible wages and prices, conditional on the current capital stock (as in Woodford 2003), or the level corresponding to a frictionless economy in which wages and prices had always been flexible (as in Nelson and Neiss 2003). Our analysis documents the relative performance of simple rules involving these definitions, and then considers the extent to which our findings are robust to various extensions of the baseline model, including variable capacity utilization, limited reallocation of capital across firms, and higher-order adjustment costs (as in Christiano, Eichenbaum and Evans 2001)
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 826.
Date of creation: 2004
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Ramsey solution; policy under commitment; welfare analysis.;
Find related papers by JEL classification:
- E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
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