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Exact utilities under alternative monetary rules in a simple macro model with optimizing agents

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  • Dale W. Henderson
  • Jinill Kim

Abstract

We construct an optimizing-agent model of a closed economy which is simple enough that we can use it to make exact utility calculations. There is a stabilization problem because there are one-period nominal contracts for wages, or prices, or both and shocks that are unknown at the time when contracts are signed. We evaluate alternative monetary policy rules using the utility function of the representative agent. Fully optimal policy can attain the Pareto-optimal equilibrium. Fully optimal policy is contrasted with both 'naive' and 'sophisticated' simple rules that involve, respectively, complete stabilization and optimal stabilization of one variable or a combination of two variables. With wage contracts, outcomes depend crucially on whether there are also price contracts. For example, if labor supply is relatively inelastic, for productivity shocks, nominal income stabilization yields higher welfare when there are no price contracts. However, with price contracts, outcomes are independent of whether there are wage contracts, except, of course, for the nominal wage.

Suggested Citation

  • Dale W. Henderson & Jinill Kim, 1999. "Exact utilities under alternative monetary rules in a simple macro model with optimizing agents," International Finance Discussion Papers 635, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:635
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    References listed on IDEAS

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    1. Kim, Jinill & Kim, Sunghyun Henry, 2003. "Spurious welfare reversals in international business cycle models," Journal of International Economics, Elsevier, vol. 60(2), pages 471-500, August.
    2. 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.
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    5. Koenig, Evan F., 1996. "Targeting nominal income: A closer look," Economics Letters, Elsevier, vol. 51(1), pages 89-93, April.
    6. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare and Macroeconomic Interdependence," The Quarterly Journal of Economics, Oxford University Press, vol. 116(2), pages 421-445.
    7. Charles Engel, 1999. "On the Foreign Exchange Risk Premium in Sticky-Price General Equilibrium Models," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 491-505, November.
    8. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.
    9. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-819, December.
    10. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
    11. Dale Henderson & Jinill Kim, 1999. "Exact Utilities under Alternative Monetary Rules in a Simple Macro Model with Optimizing Agents," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 507-535, November.
    12. 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.
    13. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2001. "Is the Price Level Determined by the Needs of Fiscal Solvency?," American Economic Review, American Economic Association, vol. 91(5), pages 1221-1238, December.
    14. Jinill Kim, 1997. "Three sources of increasing returns to scale," Finance and Economics Discussion Series 1997-18, Board of Governors of the Federal Reserve System (US).
    15. Michael B. Devereux & Charles Engel, 1998. "Fixed vs. Floating Exchange Rates: How Price Setting Affects the Optimal Choice of Exchange-Rate Regime," NBER Working Papers 6867, National Bureau of Economic Research, Inc.
    16. Fukuda, Shin-ichi & Hoshi, Takeo & Ito, Takatoshi & Rose, Andrew, 2006. "International Finance," Journal of the Japanese and International Economies, Elsevier, vol. 20(4), pages 455-458, December.
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    Citations

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    Cited by:

    1. Maurice Obstfeld, 2001. "International Macroeconomics: Beyond the Mundell-Fleming Model," NBER Working Papers 8369, National Bureau of Economic Research, Inc.
    2. Benigno, Gianluca & Benigno, Pierpaolo, 2006. "Designing targeting rules for international monetary policy cooperation," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 473-506, April.
    3. Pierpaolo Benigno, 2009. "Price Stability with Imperfect Financial Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 121-149, February.
    4. Kim, Jinill & Kim, Sunghyun Henry, 2003. "Spurious welfare reversals in international business cycle models," Journal of International Economics, Elsevier, vol. 60(2), pages 471-500, August.
    5. Canzoneri, Matthew B. & Cumby, Robert E. & Diba, Behzad T., 2005. "The need for international policy coordination: what's old, what's new, what's yet to come?," Journal of International Economics, Elsevier, vol. 66(2), pages 363-384, July.
    6. Gianluca Benigno & Pierpaolo Benigno, 2004. "Designing Target Rules for International Monetary Policy Cooperation," CEP Discussion Papers dp0666, Centre for Economic Performance, LSE.
    7. Dib, Ali, 2006. "Nominal rigidities and monetary policy in Canada," Journal of Macroeconomics, Elsevier, vol. 28(2), pages 303-325, June.
    8. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
    9. Michael Gail, 2000. "Optimal Monetary Policy in an Optimizing Stochastic Dynamic Model with Sticky Prices," Volkswirtschaftliche Diskussionsbeiträge 87-00, Universität Siegen, Fakultät Wirtschaftswissenschaften, Wirtschaftsinformatik und Wirtschaftsrecht, revised 15 May 2001.
    10. Henderson, Dale, 1999. "Monetary policy issues for the Eurosystem : A comment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 51(1), pages 137-148, December.
    11. Jinill Kim & Sunghyun Henry Kim, 1999. "Inaccuracy of Loglinear Approximation in Welfare Calculations: the Case of International Risk Sharing," Computing in Economics and Finance 1999 251, Society for Computational Economics.
    12. Dale Henderson & Jinill Kim, 1999. "Exact Utilities under Alternative Monetary Rules in a Simple Macro Model with Optimizing Agents," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 507-535, November.
    13. Eric Parrado & Andres Velasco, 2002. "Optimal Interest Rate Policy in a Small Open Economy," NBER Working Papers 8721, National Bureau of Economic Research, Inc.
    14. Kim, Jinill & Henderson, Dale W., 2005. "Inflation targeting and nominal-income-growth targeting: When and why are they suboptimal?," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1463-1495, November.

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    Keywords

    Monetary policy ; Wages ; Prices;

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