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Optimal Interest Rate Stabilization in a Basic Sticky-Price Model

  • Matthias Paustian
  • Christian Stoltenberg

This paper studies optimal monetary policy with the nominal interest rate as the single policy instrument in an economy, where firms set prices in a staggered way without indexation and real money balances contribute separately to households' utility. The optimal deterministic steady state under commitment is the Friedman rule - even if the importance assigned to the utility of money is small relative to consumption and leisure. We approximate the model around the optimal steady state as the long-run policy target. Optimal monetary policy is characterized by stabilization of the nominal interest rate instead of inflation stabilization as the predominant principle.

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File URL: http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2006-072.pdf
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Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2006-072.

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Length: 53 pages
Date of creation: Oct 2006
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2006-072
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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Optimal Fiscal and Monetary Policy Under Sticky Prices," Departmental Working Papers 200105, Rutgers University, Department of Economics.
  2. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 861-886, October.
  3. Robert G. King & Alexander L. Wolman, 1996. "Inflation Targeting in a St. Louis Model of the 21st Century," NBER Working Papers 5507, National Bureau of Economic Research, Inc.
  4. Guido Ascari, 2004. "Staggered Prices and Trend Inflation: Some Nuisances," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 642-667, July.
  5. Michael T. Kiley, 1999. "Partial adjustment and staggered price setting," Finance and Economics Discussion Series 1999-01, Board of Governors of the Federal Reserve System (U.S.).
  6. Pierpaolo Benigno & Michael Woodford, 2005. "Inflation Stabilization And Welfare: The Case Of A Distorted Steady State," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1185-1236, December.
  7. Alexander L. Wolman, 2001. "A primer on optimal monetary policy with staggered price-setting," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 27-52.
  8. Bernardino Adão & Isabel Horta Correia & Pedro Teles, 2001. "Gaps and Triangles," Working Papers w200102, Banco de Portugal, Economics and Research Department.
  9. Adam, Klaus & Billi, Roberto M, 2003. "Optimal Monetary Policy Under Commitment with a Zero Bound on Nominal Interest Rates," CEPR Discussion Papers 4111, C.E.P.R. Discussion Papers.
  10. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  11. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  12. Aubhik Khan & Robert King & Alexander L. Wolman, 2002. "Optimal monetary policy," Working Papers 02-19, Federal Reserve Bank of Philadelphia.
  13. Ireland, Peter N., 2004. "A method for taking models to the data," Journal of Economic Dynamics and Control, Elsevier, vol. 28(6), pages 1205-1226, March.
  14. Peter N. Ireland, 2009. "On the Welfare Cost of Inflation and the Recent Behavior of Money Demand," American Economic Review, American Economic Association, vol. 99(3), pages 1040-52, June.
  15. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  16. Carl Walsh, 2003. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 93(1), pages 265-278, March.
  17. Javier Andrés & J. David López-Salido & Javier Vallés, 2006. "Money in an Estimated Business Cycle Model of the Euro Area," Economic Journal, Royal Economic Society, vol. 116(511), pages 457-477, 04.
  18. Charles T. Carlstrom & Timothy S. Fuerst, 2004. "Thinking about Monetary Policy without Money," International Finance, Wiley Blackwell, vol. 7(2), pages 325-347, 07.
  19. Walsh, Carl E., 2005. "Parameter misspecification and robust monetary policy rules," Working Paper Series 0477, European Central Bank.
  20. Schmitt-Grohé, Stephanie & Uribe, Martín, 2005. "Optimal Inflation Stabilization in a Medium-Scale Macroeonomic Model," CEPR Discussion Papers 5424, C.E.P.R. Discussion Papers.
  21. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, June.
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