Optimal monetary policy in economies with "sticky-information" wages
In economies with sticky-information wage setting, policymakers legitimately give attention to output stabilization as well as price-level or inflation stabilization. Consistent with Kydland and Prescott (1990), trend deviations in prices are predicted to be negatively correlated with trend deviations in output. A variant of the Taylor rule is optimal if household consumption decisions are forward-looking. Interestingly, it is essential that policy not be made contingent on the most up-to-date estimates of potential output, potential-output growth, or the natural real interest rate. New results on the “persistence problem” and a new rationalization for McCallum’s P-bar inflation equation are also presented.