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Monetary Policy In An Estimated Optimization-Based Model With Sticky Prices And Wages

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  • Jeffery Amato, Thomas Laubach

    (Federal Reserve Bank of Kansas City)

Abstract

This paper serves two purposes. First, it provides estimates of an optimisation-based equilibrium model with sticky prices and wages. Second, the estimated model is used to analyse the welfare properties of various interest rate rules for conducting monetary policy. As shown by Erceg et al (1999), an important feature of this model is that it involves a trade-off between the variances of price and wage inflation and the output gap. This trade-off implies that it is desirable for the monetary authority to respond to more than inflation, output and past interest rates when setting the current interest rate. Indeed, the welfare optimal policy can be approximated with responses to both price and wage inflation and the past interest rate. By contrast, rules that call for a strong response to either detrended output or the output gap result in much lower level of welfare.

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2000 with number 303.

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Date of creation: 05 Jul 2000
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Handle: RePEc:sce:scecf0:303

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Postal: CEF 2000, Departament d'Economia i Empresa, Universitat Pompeu Fabra, Ramon Trias Fargas, 25,27, 08005, Barcelona, Spain
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References

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  1. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
  2. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
  3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  4. Peter N. Ireland, 1999. "A method for taking models to the data," Working Paper 9903, Federal Reserve Bank of Cleveland.
  5. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1997. "Sticky price and limited participation models of money: A comparison," European Economic Review, Elsevier, vol. 41(6), pages 1201-1249, June.
  6. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  7. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 195-214, December.
  8. Christopher J. Erceg, 1997. "Nominal wage rigidities and the propagation of monetary disturbances," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 590, Board of Governors of the Federal Reserve System (U.S.).
  9. Ben S. Bernanke & Ilian Mihov, 1998. "Measuring Monetary Policy," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 113(3), pages 869-902, August.
  10. Ireland, Peter N., 1997. "A small, structural, quarterly model for monetary policy evaluation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 47(1), pages 83-108, December.
  11. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, Elsevier, vol. 46(2), pages 281-313, October.
  12. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 1(1), pages 19-46, January.
  13. Andrew G. Haldane & Nicoletta Batini, 1998. "Forward-Looking Rules for Monetary Policy," NBER Working Papers 6543, National Bureau of Economic Research, Inc.
  14. Casey B. Mulligan, 1999. "Substition over Time: Another Look at Life-Cycle Labor Supply," NBER Chapters, in: NBER Macroeconomics Annual 1998, volume 13, pages 75-152 National Bureau of Economic Research, Inc.
  15. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  16. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 2(1), pages 1-53, February.
  17. Jeremy Berkowitz & Lutz Kilian, 2000. "Recent developments in bootstrapping time series," Econometric Reviews, Taylor & Francis Journals, Taylor & Francis Journals, vol. 19(1), pages 1-48.
  18. Kim, Jinill, 2000. "Constructing and estimating a realistic optimizing model of monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 45(2), pages 329-359, April.
  19. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
  20. Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 47-64.
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Citations

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Cited by:
  1. Alves, Sergio A Lago & Bugarin, Mirta N S, 2006. "The Role of Consumer's Risk Aversion on Price Rigidity," Computing in Economics and Finance 2006, Society for Computational Economics 128, Society for Computational Economics.
  2. Katharine S. Neiss & Edward Nelson, 2001. "The real interest rate gap as an inflation indicator," Bank of England working papers 130, Bank of England.
  3. Jean Boivin & Marc Giannoni, 2002. "Has monetary policy become less powerful?," Staff Reports 144, Federal Reserve Bank of New York.
  4. Argia Sbordone, 2002. "An optimizing model of U.S. wage and price dynamics," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  5. Jeffery D. Amato & Thomas Laubach, 1999. "Forecast-based monetary policy," Research Working Paper, Federal Reserve Bank of Kansas City 99-10, Federal Reserve Bank of Kansas City.
  6. Coenen, Gunter & Wieland, Volker, 2005. "A small estimated euro area model with rational expectations and nominal rigidities," European Economic Review, Elsevier, vol. 49(5), pages 1081-1104, July.
  7. Jondeau, E. & Le Bihan, H., 2001. "Testing for a Forward-Looking Phillips Curve. Additional Evidence from European and US Data," Working papers, Banque de France 86, Banque de France.
  8. Gunter Coenen & Volker Wieland, 2000. "A Simple Estimated Euro Area Model With Rational Expectations And Nominal Rigidities," Computing in Economics and Finance 2000, Society for Computational Economics 187, Society for Computational Economics.
  9. Coenen, Gunter, 2007. "Inflation persistence and robust monetary policy design," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 31(1), pages 111-140, January.
  10. Seonghoon Cho & Antonio Moreno, 2003. "A Structural Estimation and Interpretation of the New Keynesian Macro Model," Faculty Working Papers 14/03, School of Economics and Business Administration, University of Navarra.
  11. Frank Smets & Raf Wouters, 2002. "Monetary policy in an estimated stochastic dynamic general equilibrium model of the Euro area," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.

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