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Optimal target criteria for stabilization policy

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  • Giannoni, Marc

    (Federal Reserve Bank of New York)

  • Woodford, Michael

    () (Columbia University)

Abstract

This paper considers a general class of nonlinear rational-expectations models in which policymakers seek to maximize an objective function that may be household expected utility. We show how to derive a target criterion that is 1) consistent with the model’s structural equations, 2) strong enough to imply a unique equilibrium, and 3) optimal, in the sense that a commitment to adjust the policy instrument at all dates so as to satisfy the target criterion maximizes the objective function. The proposed optimal target criterion is a linear equation that must be satisfied by the projected paths of certain economically relevant “target variables.” It takes the same form at all times and generally involves only a small number of target variables, regardless of the size and complexity of the model. While the projected path of the economy requires information about its current state, the target criterion itself can be stated without reference to a complete description of the state of the world. We illustrate the application of the method to a nonlinear DSGE model with staggered price setting, in which the objective of policy is to maximize household expected utility.

Suggested Citation

  • Giannoni, Marc & Woodford, Michael, 2012. "Optimal target criteria for stabilization policy," Staff Reports 535, Federal Reserve Bank of New York, revised 01 Oct 2016.
  • Handle: RePEc:fip:fednsr:535
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    References listed on IDEAS

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    3. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 277-316.
    4. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Oxford University Press, pages 825-860.
    5. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, pages 1111-1146.
    6. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, pages 1661-1707.
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    12. Orphanides, Athanasios & Williams, John C., 2005. "The decline of activist stabilization policy: Natural rate misperceptions, learning, and expectations," Journal of Economic Dynamics and Control, Elsevier, pages 1927-1950.
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    20. M. H. Khalil Timamy, 2005. "Debate," Review of African Political Economy, Taylor & Francis Journals, pages 383-393.
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    Cited by:

    1. Marcin Kacperczyk & Stijn Van Nieuwerburgh & Laura Veldkamp, 2014. "Time-Varying Fund Manager Skill," Journal of Finance, American Finance Association, vol. 69(4), pages 1455-1484, August.
    2. Benigno, Pierpaolo & Woodford, Michael, 2012. "Linear-quadratic approximation of optimal policy problems," Journal of Economic Theory, Elsevier, pages 1-42.
    3. Ricardo Reis, 2013. "Central Bank Design," Journal of Economic Perspectives, American Economic Association, pages 17-44.
    4. Svensson, Lars E.O., 2010. "Inflation Targeting," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 22, pages 1237-1302 Elsevier.
    5. O. Loisel, 2015. "The Implementation of Stabilization Policy," Working papers 556, Banque de France.
    6. Stefan Laséen & Lars E.O. Svensson, 2009. "Anticipated Alternative Instrument-Rate Paths in Policy Simulations," NBER Working Papers 14902, National Bureau of Economic Research, Inc.
    7. Olivier Loisel, 2016. "The Implementation of Stabilization Policy," 2016 Meeting Papers 16, Society for Economic Dynamics.
    8. Akıncı, Özge, 2013. "Global financial conditions, country spreads and macroeconomic fluctuations in emerging countries," Journal of International Economics, Elsevier, vol. 91(2), pages 358-371.
    9. Arayssi, Mahmoud, 2015. "Transparent rules for deposing central bankers," International Review of Economics & Finance, Elsevier, pages 1-17.
    10. Davide Debortoli & Junior Maih & Ricardo Nunes, 2010. "Loose commitment in medium-scale macroeconomic models: Theory and an application," Working Paper 2010/25, Norges Bank.
    11. Giannoni, Marc P., 2014. "Optimal interest-rate rules and inflation stabilization versus price-level stabilization," Journal of Economic Dynamics and Control, Elsevier, pages 110-129.
    12. Luigi Paciello & Mirko Wiederholt, 2014. "Exogenous Information, Endogenous Information, and Optimal Monetary Policy," Review of Economic Studies, Oxford University Press, pages 356-388.
    13. Adam, Klaus & Woodford, Michael, 2012. "Robustly optimal monetary policy in a microfounded New Keynesian model," Journal of Monetary Economics, Elsevier, pages 468-487.
    14. Benigno, Pierpaolo & Woodford, Michael, 2012. "Linear-quadratic approximation of optimal policy problems," Journal of Economic Theory, Elsevier, pages 1-42.
    15. Aeimit Lakdawala & Davide Debortoli, 2013. "How credible is the Federal Reserve?:A structural estimation of policy re-optimizations," 2013 Meeting Papers 1333, Society for Economic Dynamics.
    16. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1371-1406.
    17. Eusepi, Stefano & Giannoni, Marc & Preston, Bruce, 2012. "Long-Term Debt Pricing and Monetary Policy Transmission under Imperfect Knowledge," CEPR Discussion Papers 8845, C.E.P.R. Discussion Papers.
    18. Marc P. Giannoni, 2010. "Optimal Interest-Rate Rules in a Forward-Looking Model, and Inflation Stabilization versus Price-Level Stabilization," NBER Working Papers 15986, National Bureau of Economic Research, Inc.
    19. Coroneo, Laura & Corradi, Valentina & Santos Monteiro, Paulo, 2012. "Testing for optimal monetary policy via moment inequalities," The Warwick Economics Research Paper Series (TWERPS) 985, University of Warwick, Department of Economics.
    20. Giannoni, Marc P., 2014. "Optimal interest-rate rules and inflation stabilization versus price-level stabilization," Journal of Economic Dynamics and Control, Elsevier, pages 110-129.
    21. Davide Debortoli & Aeimit Lakdawala, 2016. "How Credible Is the Federal Reserve? A Structural Estimation of Policy Re-optimizations," American Economic Journal: Macroeconomics, American Economic Association, pages 42-76.
    22. Olivier Loisel, 2013. "The Implementation of Stabilization Policy," Working Papers 2013-24, Center for Research in Economics and Statistics.
    23. Svensson, Lars E.O., 2010. "Inflation Targeting," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 22, pages 1237-1302 Elsevier.

    More about this item

    Keywords

    optimal policy; target criterion; dynamic model; optimal control;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • 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

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