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Optimal Interest Rate Rules Under One-Sided Output and Inflation Targets

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  • Peter J. Stemp
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    We investigate the derivation of optimal interest rate rules in a simple stochastic framework. The monetary authority chooses to minimise an asymmetric loss function, where the monetary authority places positive weight on negative (positive) deviations of output (inflation) and zero weight on positive (negative) deviations. Our focus is on deriving optimal interest rate rules in a series of special cases where shocks come from only one sector. We show that whether or not the optimal rules derived under asymmetric loss functions will be different than the optimal rules derived under symmetric loss functions is crucially dependent on the interest rate rule chosen. Under a fixed interest rate rule, the optimal rules differ. However, under a more flexible linear interest rate rule that incorporates additional information about contemporaneous shocks, the optimal rules are the same. The approach adopted here could be used, in conjunction with computational techniques, to calculate the precise coefficients of optimal interest rate rules derived from asymmetric preferences.

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    Paper provided by Monash University, Department of Economics in its series Monash Economics Working Papers with number 32-09.

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    Length: 32 pages
    Date of creation: Aug 2009
    Handle: RePEc:mos:moswps:2009-32
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    Department of Economics, Monash University, Victoria 3800, Australia

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