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Optimal target criteria for stabilization policy

  • Marc P. Giannoni
  • Michael Woodford

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.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 535.

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Date of creation: 2012
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Handle: RePEc:fip:fednsr:535
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  1. M. H. Khalil Timamy, 2005. "Debate," Review of African Political Economy, Taylor & Francis Journals, vol. 32(104-105), pages 383-393, June.
  2. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," NBER Working Papers 9419, National Bureau of Economic Research, Inc.
  3. Benigno, Pierpaolo & Woodford, Michael, 2012. "Linear-quadratic approximation of optimal policy problems," Journal of Economic Theory, Elsevier, vol. 147(1), pages 1-42.
  4. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," NBER Working Papers 10838, National Bureau of Economic Research, Inc.
  5. Michael Woodford, 2012. "Forecast Targeting as a Monetary Policy Strategy - Policy Rules in Practice," Book Chapters, in: Evan F. Koenig & Robert Leeson & George A. Kahn (ed.), The Taylor Rule and the Transformation of Monetary Policy, chapter 9 Hoover Institution, Stanford University.
  6. repec:cup:cbooks:9780521441964 is not listed on IDEAS
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