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Optimal interest rate stabilization in a basic sticky-price model

  • Paustian, Matthias
  • Stoltenberg, Christian

This paper studies optimal monetary policy with the nominal interest rate as the single policy instrument in an economy, where firms set prices in a staggered way without indexation and real money balances contribute separately to households' utility. The optimal deterministic steady state under commitment is the Friedman rule - even if the importance assigned to the utility of money is small relative to consumption and leisure. We approximate the model around the optimal steady state as the long-run policy target. Optimal monetary policy is characterized by stabilization of the nominal interest rate instead of inflation stabilization as the predominant principle.

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File URL: http://www.sciencedirect.com/science/article/pii/S0165-1889(08)00014-6
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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 32 (2008)
Issue (Month): 10 (October)
Pages: 3166-3191

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Handle: RePEc:eee:dyncon:v:32:y:2008:i:10:p:3166-3191
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Alexander L. Wolman, 2001. "A primer on optimal monetary policy with staggered price-setting," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 27-52.
  2. Roberto M. Billi & Klaus Adam, 2004. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 2004 67, Society for Computational Economics.
  3. Aubhik Khan & Robert King & Alexander L. Wolman, 2002. "Optimal monetary policy," Working Papers 02-19, Federal Reserve Bank of Philadelphia.
  4. Ascari, Guido, 2003. "Staggered prices and trend inflation : Some nuisances," Research Discussion Papers 27/2003, Bank of Finland.
  5. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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  10. Robert G. King & Alexander L. Wolman, 1996. "Inflation targeting in a St. Louis model of the 21st century," Review, Federal Reserve Bank of St. Louis, issue May, pages 83-107.
  11. Walsh, Carl E., 2005. "Parameter misspecification and robust monetary policy rules," Working Paper Series 0477, European Central Bank.
  12. Stephanie Schmitt-Grohe & Martin Uribe, 2005. "Optimal Inflation Stabilization in a Medium-Scale Macroeconomic Model," NBER Working Papers 11854, National Bureau of Economic Research, Inc.
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  14. Ireland, Peter N., 2004. "A method for taking models to the data," Journal of Economic Dynamics and Control, Elsevier, vol. 28(6), pages 1205-1226, March.
  15. Michael T. Kiley, 1999. "Partial adjustment and staggered price setting," Finance and Economics Discussion Series 1999-01, Board of Governors of the Federal Reserve System (U.S.).
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  18. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  19. Charles T. Carlstrom & Timothy S. Fuerst, 2004. "Thinking about Monetary Policy without Money," International Finance, Wiley Blackwell, vol. 7(2), pages 325-347, 07.
  20. Javier Andrés & J. David López-Salido & Javier Vallés, 2006. "Money in an Estimated Business Cycle Model of the Euro Area," Economic Journal, Royal Economic Society, vol. 116(511), pages 457-477, 04.
  21. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
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