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Optimal monetary policy in the generalized Taylor economy

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  • Kara, Engin

Abstract

In this paper we use the Generalized Taylor Economy (GTE) framework in which there are many sectors with overlapping contracts of different lengths to analyze the design of monetary policy. We derive a utility based objective function of a central bank for this economy and use it to evaluate the performance of alternative simple rules. We find that a simple rule that targets an index that gives more weight to the sectors which have longer contracts and are more important in the aggregate index yields a welfare outcome nearly identical to the optimal policy. However, we find that potential gains in targeting sector specific inflation rates rather than the aggregate inflation rate is very sensitive to the shape of the distribution. We show that except for the cases where prices/wages are reoptimized very frequently, the performance of the sectoral rule can be closely approximated by a simple rule that targets aggregate inflation. JEL Classification: E32, E52, E58

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  • Kara, Engin, 2006. "Optimal monetary policy in the generalized Taylor economy," Working Paper Series 673, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:2006673
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Engin Kara, 2012. "Using Micro Data on Prices to Improve Business Cycle Models," Bristol Economics Discussion Papers 12/632, Department of Economics, University of Bristol, UK.
    2. Engin Kara, 2011. "Understanding and Modelling Reset Price Inflation," Bristol Economics Discussion Papers 11/623, Department of Economics, University of Bristol, UK.
    3. Huw David Dixon & Kun Tian, 2017. "What We can Learn About the Behaviour of Firms from the Average Monthly Frequency of Price-Changes: An Application to the UK CPI Data," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 79(6), pages 907-932, December.
    4. Huw Dixon & Hervé Le Bihan, 2012. "Generalised Taylor and Generalised Calvo Price and Wage Setting: Micro‐evidence with Macro Implications," Economic Journal, Royal Economic Society, vol. 122(560), pages 532-554, May.
    5. Dixon, Huw & Kara, Engin, 2011. "Contract length heterogeneity and the persistence of monetary shocks in a dynamic generalized Taylor economy," European Economic Review, Elsevier, vol. 55(2), pages 280-292, February.
    6. Kara Engin, 2011. "Micro-Data on Nominal Rigidity, Inflation Persistence and Optimal Monetary Policy," The B.E. Journal of Macroeconomics, De Gruyter, vol. 11(1), pages 1-19, July.
    7. Taylor, J.B., 2016. "The Staying Power of Staggered Wage and Price Setting Models in Macroeconomics," Handbook of Macroeconomics, Elsevier.
    8. Huw Dixon & Engin Kara, 2011. "Taking Multi-Sector Dynamic General Equilibrium Models to the Data," Koç University-TUSIAD Economic Research Forum Working Papers 1125, Koc University-TUSIAD Economic Research Forum.
    9. Dixon, Huw & Franklin, Jeremy & Millard, Stephen, 2014. "Sectoral shocks and monetary policy in the United Kingdom," Bank of England working papers 499, Bank of England.
    10. Engin Kara & Yongmin Park, 2017. "Heterogeneity in Staggered Wage Bargaining and Unemployment Volatility Puzzle," CESifo Working Paper Series 6536, CESifo Group Munich.

    More about this item

    Keywords

    inflation targeting; Optimal Monetary Policy.;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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