IDEAS home Printed from https://ideas.repec.org/p/jhu/papers/491.html
   My bibliography  Save this paper

Monetary Policy for Inattentive Economies

Author

Listed:
  • Laurence Ball
  • N Gregory Mankiw
  • Ricardo Reis

Abstract

This paper is a contribution to the analysis of optimal monetary policy. It begins with a critical assessment of the existing literature, arguing that most work is based on implausible models of inflation-output dynamics. It then suggests that this problem may be solved with some recent behavioral models, which assume that price setters are slow to incorporate macroeconomic information into the prices they set. A specific such model is developed and used to derive optimal policy. In response to shocks to productivity and aggregate demand, optimal policy is price level targeting. Base drift in the price level, which is implicit in the inflation targeting regimes currently used in many central banks, is not desirable in this model. When shocks to desired markups are added, optimal policy is flexible targeting of the price level. That is, the central bank should allow the price level to deviate from its target for a while in response to these supply shocks, but it should eventually return the price level to its target path. Optimal policy can also be described as an elastic price standard: the central bank allows the price level to deviate from its target when output is expected to deviate from its natural rate.

Suggested Citation

  • Laurence Ball & N Gregory Mankiw & Ricardo Reis, 2003. "Monetary Policy for Inattentive Economies," Economics Working Paper Archive 491, The Johns Hopkins University,Department of Economics.
  • Handle: RePEc:jhu:papers:491
    as

    Download full text from publisher

    File URL: http://www.econ2.jhu.edu/REPEC/papers/WP491_ball2.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. repec:nbr:nberre:0126 is not listed on IDEAS
    2. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    3. Lars E. O. Svensson, 1996. "Price Level Targeting vs. Inflation Targeting: A Free Lunch?," NBER Working Papers 5719, National Bureau of Economic Research, Inc.
    4. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    5. Mankiw, N Gregory, 2001. "The Inexorable and Mysterious Tradeoff between Inflation and Unemployment," Economic Journal, Royal Economic Society, vol. 111(471), pages 45-61, May.
    6. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
    7. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1295-1328.
    8. James Peery Cover & Paul Pecorino, 2005. "Price and Output Stability under Price-Level Targeting," Southern Economic Journal, John Wiley & Sons, vol. 72(1), pages 152-166, July.
    9. Laurence Ball, 1999. "Efficient Rules for Monetary Policy," International Finance, Wiley Blackwell, vol. 2(1), pages 63-83, April.
    10. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-334, June.
    11. Laurence Ball & N. Gregory Mankiw, 1995. "Relative-Price Changes as Aggregate Supply Shocks," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 161-193.
    12. Robert J. Gordon, 1997. "The Time-Varying NAIRU and Its Implications for Economic Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 11-32, Winter.
    13. Alogoskoufis, George S & Smith, Ron, 1991. "The Phillips Curve, the Persistence of Inflation, and the Lucas Critique: Evidence from Exchange-Rate Regimes," American Economic Review, American Economic Association, vol. 81(5), pages 1254-1275, December.
    14. Xavier Gabaix & David Laibson, 2002. "The 6D Bias and the Equity-Premium Puzzle," NBER Chapters, in: NBER Macroeconomics Annual 2001, Volume 16, pages 257-330, National Bureau of Economic Research, Inc.
    15. Aoki, Kosuke, 2006. "Optimal commitment policy under noisy information," Journal of Economic Dynamics and Control, Elsevier, vol. 30(1), pages 81-109, January.
    16. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
    17. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
    18. George A. Akerlof, 2003. "Behavioral Macroeconomics and Macroeconomic Behavior," The American Economist, Sage Publications, vol. 47(1), pages 25-47, March.
    19. Robert E. Hall, 1984. "Monetary strategy with an elastic price standard," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 137-167.
    20. Laurence Ball, 2000. "Near-rationality and inflation in two monetary regimes," Proceedings, Federal Reserve Bank of San Francisco.
    21. Barsky, Robert B., 1987. "The Fisher hypothesis and the forecastability and persistence of inflation," Journal of Monetary Economics, Elsevier, vol. 19(1), pages 3-24, January.
    22. Ball, Laurence & Gregory Mankiw, N. & Reis, Ricardo, 2005. "Monetary policy for inattentive economies," Journal of Monetary Economics, Elsevier, vol. 52(4), pages 703-725, May.
    23. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
    24. Douglas Staiger & James H. Stock & Mark W. Watson, 1997. "The NAIRU, Unemployment and Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 33-49, Winter.
    25. Robert E. Hall & N. Gregory Mankiw, 1994. "Nominal Income Targeting," NBER Chapters, in: Monetary Policy, pages 71-94, National Bureau of Economic Research, Inc.
    26. Clarida, Richard & Gali, Jordi & Gertler, Mark, 2002. "A simple framework for international monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 879-904, July.
    27. Ball, Laurence, 1994. "Credible Disinflation with Staggered Price-Setting," American Economic Review, American Economic Association, vol. 84(1), pages 282-289, March.
    28. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404, National Bureau of Economic Research, Inc.
    29. Julio J. Rotemberg, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Oxford University Press, vol. 49(4), pages 517-531.
    30. Michael Woodford, 2001. "Imperfect Common Knowledge and the Effects of Monetary Policy," NBER Working Papers 8673, National Bureau of Economic Research, Inc.
    31. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296, National Bureau of Economic Research, Inc.
    32. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
    33. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    34. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Thorvardur Tjörvi Ólafsson, 2006. "The New Keynesian Phillips Curve: In Search of Improvements and Adaptation to the Open Economy," Economics wp31_tjorvi, Department of Economics, Central bank of Iceland.
    2. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky Information: A Model of Monetary Nonneutrality and Structural Slumps," Harvard Institute of Economic Research Working Papers 1941, Harvard - Institute of Economic Research.
    3. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1295-1328.
    4. Mankiw, N Gregory, 2001. "The Inexorable and Mysterious Tradeoff between Inflation and Unemployment," Economic Journal, Royal Economic Society, vol. 111(471), pages 45-61, May.
    5. Marika Karanassou & Hector Sala & Dennis J. Snower, 2010. "Phillips Curves And Unemployment Dynamics: A Critique And A Holistic Perspective," Journal of Economic Surveys, Wiley Blackwell, vol. 24(1), pages 1-51, February.
    6. Driscoll, John C. & Holden, Steinar, 2014. "Behavioral economics and macroeconomic models," Journal of Macroeconomics, Elsevier, vol. 41(C), pages 133-147.
    7. N. Gregory Mankiw, 2007. ""Comments Presented at Federal Reserve Conference" Price Dynamics: Three Open Questions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 187-192, February.
    8. Holden, Steinar, 2012. "Implications of Insights from Behavioral Economics for Macroeconomic Models," Memorandum 25/2012, Oslo University, Department of Economics.
    9. Karanassou, Marika & Sala, Hector & Snower, Dennis J., 2005. "A reappraisal of the inflation-unemployment tradeoff," European Journal of Political Economy, Elsevier, vol. 21(1), pages 1-32, March.
    10. Michael Kumhof & Douglas Laxton, 2005. "A Rational Expectations Model of Optimal Inflation Inertia," Computing in Economics and Finance 2005 429, Society for Computational Economics.
    11. Bayoumi, Tamim & Sgherri, Silvia, 2004. "Deconstructing the Art of Central Banking," CEPR Discussion Papers 4675, C.E.P.R. Discussion Papers.
    12. Bhavesh Salunkhe & Anuradha Patnaik, 2019. "Inflation Dynamics and Monetary Policy in India: A New Keynesian Phillips Curve Perspective," South Asian Journal of Macroeconomics and Public Finance, , vol. 8(2), pages 144-179, December.
    13. Arslan, M. Murat, 2008. "Dynamics of sticky information and sticky price models in a New Keynesian DSGE framework," Economic Modelling, Elsevier, vol. 25(6), pages 1276-1294, November.
    14. Jensen, Christian, 2014. "Discretionary policy exploiting learning in a sticky-information model of the inflation-output trade-off: Bridging the gap to commitment," Journal of Macroeconomics, Elsevier, vol. 40(C), pages 150-158.
    15. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    16. Kevin Lansing, 2009. "Time Varying U.S. Inflation Dynamics and the New Keynesian Phillips Curve," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(2), pages 304-326, April.
    17. Henrik Jensen, 2002. "Targeting Nominal Income Growth or Inflation?," American Economic Review, American Economic Association, vol. 92(4), pages 928-956, September.
    18. Chengsi Zhang & Denise R. Osborn & Dong Heon Kim, 2008. "The New Keynesian Phillips Curve: From Sticky Inflation to Sticky Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 667-699, June.
    19. Nessen, Marianne & Vestin, David, 2005. "Average Inflation Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 837-863, October.
    20. Gaspar, Vítor & Levin, Andrew & Martins, Fernando Manuel & Smets, Frank, 2007. "Evidence from Surveys of Price-Setting Managers: Policy Lessons and Directions for Ongoing Research," CEPR Discussion Papers 6227, C.E.P.R. Discussion Papers.

    More about this item

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:jhu:papers:491. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://edirc.repec.org/data/dejhuus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Alan Fisher (email available below). General contact details of provider: https://edirc.repec.org/data/dejhuus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.