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Optimal Monetary Stabilization Policy

  • Michael Woodford

This paper reviews the theory of optimal monetary stabilization policy, with an emphasis on developments since the publication of Woodford (2003). The structure of optimal policy commitments is considered, both when the objective of stabilization policy is defined by an arbitrarily specified quadratic loss function, and when the objective of policy is taken to be the maximization of expected utility. Issues treated include the time inconsistency of optimal policies and the need for commitment; the relation of optimal policy from a "timeless perspective" to the Ramsey conception of optimal policy; and the advantages of forecast targeting procedures as an approach to the implementation of optimal stabilization policy. The usefulness of characterizing optimal policy in terms of a target criterion is illustrated in a range of examples. These include models with a variety of assumptions about the nature of price and wage adjustment; models that allow for sectoral heterogeneity; cases in which policy must be conducted on the basis of imperfect information; and cases in which the zero lower bound on the policy rate constrains the conduct of policy.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16095.

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Date of creation: Jun 2010
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Publication status: published as “Optimal Monetary Stabilization Policy,” in B.M. Friedman and M. Woodford, eds., Handbook of Monetary Economics, vol. 3B, Amsterdam: Elsevier, 2011.
Handle: RePEc:nbr:nberwo:16095
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  1. Pierpaolo Benigno & Michael Woodford, 2004. "Optimal Monetary and Fiscal Policy: A Linear-Quadratic Approach," NBER Chapters, in: NBER Macroeconomics Annual 2003, Volume 18, pages 271-364 National Bureau of Economic Research, Inc.
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  16. Levin, Andrew & López-Salido, J David & Nelson, Edward & Yun, Tack, 2009. "Limitations on the Effectiveness of Forward Guidance at the Zero Lower Bound," CEPR Discussion Papers 7581, C.E.P.R. Discussion Papers.
  17. Kosuke Aoki & Kalin Nikolov, 2004. "Rule-based monetary policy under central bank learning," Bank of England working papers 235, Bank of England.
  18. Benigno, Pierpaolo, 2004. "Optimal monetary policy in a currency area," Journal of International Economics, Elsevier, vol. 63(2), pages 293-320, July.
  19. Emi Nakamura & Jón Steinsson, 2010. "Monetary Non-neutrality in a Multisector Menu Cost Model," The Quarterly Journal of Economics, Oxford University Press, vol. 125(3), pages 961-1013.
  20. Pierpaolo Benigno & Michael Woodford, 2005. "Optimal stabilization policy when wages and prices are sticky: the case of a distorted steady state," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 127-180.
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  23. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  24. Schmitt-Grohé, Stephanie & Uribe, Martín, 2010. "The Optimal Rate of Inflation," CEPR Discussion Papers 7864, C.E.P.R. Discussion Papers.
  25. Kim, Jinill & Kim, Sunghyun Henry, 2003. "Spurious welfare reversals in international business cycle models," Journal of International Economics, Elsevier, vol. 60(2), pages 471-500, August.
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  27. Blake, Andrew P., 2002. "A 'Timeless Perspective' on Optimality in Forward-Looking Rational Expectations Models," Royal Economic Society Annual Conference 2002 30, Royal Economic Society.
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  29. Carlos Carvalho, 2005. "Heterogeneity in Price Setting and the Real Effects of Monetary Shocks," Macroeconomics 0509017, EconWPA, revised 12 Sep 2005.
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  32. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
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  36. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
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  42. repec:clu:wpaper:0910-10 is not listed on IDEAS
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