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Optimal Interest-Rate Rules: I. General Theory

  • Marc P. Giannoni
  • Michael Woodford

This paper proposes a general method for deriving an optimal monetary policy rule in the case of a dynamic linear rational-expectations model and a quadratic objective function for policy. A commitment to a rule of the type proposed results in a determinate equilibrium in which the responses to shocks are optimal. Furthermore, the optimality of the proposed policy rule is independent of the specification of the stochastic disturbances. Finally, the proposed rules can be justified from a timeless perspective,' so that commitment to such a rule need not imply time-inconsistent policy. We show that under fairly general condition, optimal policy can by represented by a generalized Taylor rule, in which however the relation between the interest-rate instrument and the other target variables is not purely contemporaneous, as in Taylor's specification. We also offer general conditions under which optimal policy can be represented by a 'super-inertial' interest-rate rule, and under which it can be represented by a pure 'targeting rule' that makes no explicit reference to the path of the instrument.

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File URL: http://www.nber.org/papers/w9419.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9419.

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Date of creation: Jan 2003
Date of revision:
Handle: RePEc:nbr:nberwo:9419
Note: EFG ME
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters, in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
  2. Rudebusch, G.D. & Svensson, L.E.O., 1998. "Policy Rules for Inflation Targeting," Papers 637, Stockholm - International Economic Studies.
  3. Marc P. Giannoni, 2007. "Robust optimal monetary policy in a forward-looking model with parameter and shock uncertainty," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(1), pages 179-213.
  4. Nicoletta Batini & Joseph Pearlman, 2002. "Too Much Too Soon: Instability and Indeterminacy with Forward-Looking Rules," Discussion Papers 08, Monetary Policy Committee Unit, Bank of England.
  5. Andrew Levin & Volker Wieland & John C. Williams, 2001. "The performance of forecast-based monetary policy rules under model uncertainty," Finance and Economics Discussion Series 2001-39, Board of Governors of the Federal Reserve System (U.S.).
  6. repec:cup:cbooks:9780521441964 is not listed on IDEAS
  7. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
  8. repec:cup:cbooks:9780521104609 is not listed on IDEAS
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