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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. 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.
  2. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 825-860.
  3. 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.
  4. Peter N. Ireland, 2008. "On the Welfare Cost of Inflation and the Recent Behavior of Money Demand," NBER Working Papers 14098, National Bureau of Economic Research, Inc.
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  6. Stephanie Schmitt-Grohe & Martin Uribe, 2005. "Optimal Inflation Stabilization in a Medium-Scale Macroeconomic Model," NBER Working Papers 11854, National Bureau of Economic Research, Inc.
  7. Bernardino Adão & Isabel Correia & Pedro Teles, 2001. "Gaps and triangles," Working Paper Series WP-01-13, Federal Reserve Bank of Chicago.
  8. Robert G. King & Alexander L. Wolman, 1996. "Inflation targeting in a St. Louis model of the 21st century," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 83-107.
  9. 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.
  10. 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.
  11. Roberto M. Billi & Klaus Adam, 2004. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 2004 67, Society for Computational Economics.
  12. Kiley, Michael T, 2002. "Partial Adjustment and Staggered Price Setting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(2), pages 283-98, May.
  13. Martin Uribe & Stephanie Schmitt-Grohe, 2001. "Optimal fiscal and monetary policy under sticky prices," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  14. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  15. 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.
  16. 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.
  17. Guido Ascari, 2004. "Staggered prices and trend inflation: some nuisances," Macroeconomics 0404029, EconWPA.
  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. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 861-886, October.
  20. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, June.
  21. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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