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Optimal monetary policy in an economy with sticky nominal wages

  • Evan F. Koenig

In this article, Evan Koenig derives the optimal monetary policy rule for an economy with contractual wage agreements. The optimal rule has the monetary authority target a weighted average of aggregate output and the price level. In a realistic special case, the optimal rule calls for the monetary authority to target aggregate nominal spending. The optimal rule is quite general in form, encompassing policy proposals made by such prominent economists as Robert Hall and John Taylor. ; Koenig points out that if the monetary authority responds optimally to economic shocks, it will be difficult to distinguish the effects of monetary policy from the effects of the shocks themselves. So, the important contribution that monetary policy makes to the economy may easily be overlooked. Paradoxically, only insofar as monetary policy is implemented with error will it be apparent that monetary policy matters.

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File URL: http://www.dallasfed.org/assets/documents/research/er/1995/er9502c.pdf
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Article provided by Federal Reserve Bank of Dallas in its journal Economic and Financial Policy Review.

Volume (Year): (1995)
Issue (Month): Q II ()
Pages: 24-31

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Handle: RePEc:fip:fedder:y:1995:i:qii:p:24-31
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  1. Card, David, 1990. "Unexpected Inflation, Real Wages, and Employment Determination in Union Contracts," American Economic Review, American Economic Association, vol. 80(4), pages 669-88, September.
  2. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  3. McLaughlin, Kenneth J., 1994. "Rigid wages?," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 383-414, December.
  4. Robert E. Hall, 1984. "Monetary strategy with an elastic price standard," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 137-167.
  5. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  6. Laurence Ball & N. Gregory Mankiw, 1994. "A Sticky-Price Manifesto," NBER Working Papers 4677, National Bureau of Economic Research, Inc.
  7. 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.
  8. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-19, December.
  9. Jang-Ok Cho, 1993. "Money and Business Cycle with One-Period Nominal Contracts," Canadian Journal of Economics, Canadian Economics Association, vol. 26(3), pages 638-59, August.
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