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Optimal Monetary Policy Inertia

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  • Woodford, Michael

    (Princeton University)

Abstract

I consider the desirability of the observed tendency of central banks to adjust interest rates only gradually in response to changes in economic conditions. I show, in the context of a simple model of optimizing private sector behaviour, that such inertial behaviour on the part of the central bank may indeed be optimal, in the sense of minimizing a loss function that penalizes inflation variations, deviations of output from potential and interest rate variability. Sluggish adjustment characterizes an optimal policy commitment, even though no such inertia would be present in the case of discretionary optimization.
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Suggested Citation

  • Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies.
  • Handle: RePEc:hhs:iiessp:0666
    Note: A later version of the paper is also available as NBER working paper no. 7261, July 1999, and at the author's web page at www.princeton.edu/~woodford.
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    More about this item

    Keywords

    commitment; discretion; interest-rate smoothing; monetary policy rules; forward-looking models; natural rate of interest;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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