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Monetary policy in an estimated optimisation-based model with sticky prices and wages

  • Thomas Laubach

    (Federal Reserve Board)

  • Jeffery D. Amato

    (Goldman Sachs International)

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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Paper provided by Bank for International Settlements in its series BIS Working Papers with number 87.

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Length: 46 pages
Date of creation: May 2000
Date of revision:
Handle: RePEc:bis:biswps:87
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  1. Christopher J. Erceg, 1997. "Nominal wage rigidities and the propagation of monetary disturbances," International Finance Discussion Papers 590, Board of Governors of the Federal Reserve System (U.S.).
  2. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  3. Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies.
  4. Jeremy Berkowitz & Lutz Kilian, 2000. "Recent developments in bootstrapping time series," Econometric Reviews, Taylor & Francis Journals, vol. 19(1), pages 1-48.
  5. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-53, February.
  6. 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.
  7. Kim, Jinill, 2000. "Constructing and estimating a realistic optimizing model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 45(2), pages 329-359, April.
  8. Casey B. Mulligan, 1998. "Substitution over Time: Another Look at Life Cycle Labor Supply," NBER Working Papers 6585, National Bureau of Economic Research, Inc.
  9. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
  10. Ireland, Peter N., 1997. "A small, structural, quarterly model for monetary policy evaluation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 83-108, December.
  11. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters, in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
  12. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky Price and Limited Participation Models of Money: A Comparison," NBER Working Papers 5804, National Bureau of Economic Research, Inc.
  13. Peter N. Ireland, 1999. "A method for taking models to the data," Working Paper 9903, Federal Reserve Bank of Cleveland.
  14. 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.
  15. Ben S. Bernanke & Ilian Mihov, 1995. "Measuring monetary policy," Working Papers in Applied Economic Theory 95-09, Federal Reserve Bank of San Francisco.
  16. 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.
  17. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, October.
  18. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  19. 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.
  20. 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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