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Delegating Optimal Monetary Policy Inertia

  • Bilbiie, Florin Ovidiu

This paper shows that absent a commitment technology, central banks can nevertheless achieve the (timeless-)optimal commitment equilibrium if they are delegated with an objective function that is different from the societal one. In a prototypical forward-looking New Keynesian model, I develop a general linear-quadratic method to solve for the optimal delegation parameters that generate the optimal amount of inertia in a Markov-perfect equilibrium. I study the optimal design of some policy regimes that are nested within this framework: inflation, output-gap growth and nominal income growth targeting; and inflation and output-gap contracts. Notably, since the timeless-optimal equilibrium is time-consistent, so is any delegation scheme that implements it.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7482.

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Date of creation: Oct 2009
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Handle: RePEc:cpr:ceprdp:7482
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  1. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
  2. Robert E. Hall & N. Gregory Mankiw, 1994. "Nominal Income Targeting," NBER Chapters, in: Monetary Policy, pages 71-94 National Bureau of Economic Research, Inc.
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  8. Dennis, Richard, 2010. "When is discretion superior to timeless perspective policymaking?," Journal of Monetary Economics, Elsevier, vol. 57(3), pages 266-277, April.
  9. Bilbiie, Florin O., 2008. "Limited asset markets participation, monetary policy and (inverted) aggregate demand logic," Journal of Economic Theory, Elsevier, vol. 140(1), pages 162-196, May.
  10. Gary S. Anderson & Jinill Kim & Tack Yun, 2010. "Using a projection method to analyze inflation bias in a micro-founded model," Finance and Economics Discussion Series 2010-18, Board of Governors of the Federal Reserve System (U.S.).
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  12. Smets, Frank & Wouters, Raf, 2007. "Shocks and frictions in US business cycles: a Bayesian DSGE approach," Working Paper Series 0722, European Central Bank.
  13. McCallum, Bennett T & Nelson, Edward, 2001. "Timeless Perspective Vs Discretionary Monetary Policy in Forward-Looking Models," CEPR Discussion Papers 2752, C.E.P.R. Discussion Papers.
  14. Lockwood, Ben & Miller, Marcus & Zhang, Lei, 1998. "Designing Monetary Policy When Unemployment Persists," Economica, London School of Economics and Political Science, vol. 65(259), pages 327-45, August.
  15. Lockwood, Ben, 1997. "State-Contingent Inflation Contracts and Unemployment Persistence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 286-99, August.
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  18. McCallum, Bennett T, 1995. "Two Fallacies Concerning Central-Bank Independence," American Economic Review, American Economic Association, vol. 85(2), pages 207-11, May.
  19. D. Backus & J. Driffil, 1998. "Inflation and Reputation," Levine's Working Paper Archive 625, David K. Levine.
  20. Benigno, Gianluca & Benigno, Pierpaolo, 2008. "Implementing International Monetary Cooperation Through Inflation Targeting," Macroeconomic Dynamics, Cambridge University Press, vol. 12(S1), pages 45-59, April.
  21. Niemann, Stefan & Pichler, Paul & Sorger, Gerhard, 2009. "Inflation dynamics under optimal discretionary fiscal and monetary policies," Economics Discussion Papers 2898, University of Essex, Department of Economics.
  22. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  23. 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.
  24. Persson, Torsten & Tabellini, Guido, 1993. "Designing institutions for monetary stability," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 53-84, December.
  25. Taylor, John B, 1982. "Establishing Credibility: A Rational Expectations Viewpoint," American Economic Review, American Economic Association, vol. 72(2), pages 81-85, May.
  26. Canzoneri, Matthew B, 1985. "Monetary Policy Games and the Role of Private Information," American Economic Review, American Economic Association, vol. 75(5), pages 1056-70, December.
  27. Vestin, David, 2006. "Price-level versus inflation targeting," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1361-1376, October.
  28. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
  29. Willem Van Zandweghe & Alexander L. Wolman, 2011. "Discretionary monetary policy in the Calvo model," Working Paper 11-03, Federal Reserve Bank of Richmond.
  30. Roel M.W.J. Beetsma & Henrik Jensen, . "Optimal Inflation Targets, “Conservative” Central Banks, and Linear Inflation Contracts: Comment," EPRU Working Paper Series 98-11, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  31. Thompson, Earl A, 1981. "Who Should Control the Money Supply?," American Economic Review, American Economic Association, vol. 71(2), pages 356-61, May.
  32. Gianluca Benigno & Pierpaolo Benigno, 2004. "Designing Target Rules for International Monetary Policy Cooperation," CEP Discussion Papers dp0666, Centre for Economic Performance, LSE.
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