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Monetary Policy for Inattentive Economies

  • Laurence Ball
  • N. Gregory Mankiw
  • Ricardo Reis

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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9491.

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Date of creation: Feb 2003
Date of revision:
Publication status: published as 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.
Handle: RePEc:nbr:nberwo:9491
Note: EFG ME
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  1. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," NBER Working Papers 8290, National Bureau of Economic Research, Inc.
  2. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  3. Laurence Ball & N. Gregory Mankiw, 1993. "Relative-price changes as aggregate supply shocks," Working Papers 93-13, Federal Reserve Bank of Philadelphia.
  4. 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.
  5. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  6. Laurence Ball, 1990. "Credible Disinflation with Staggered Price Setting," NBER Working Papers 3555, National Bureau of Economic Research, Inc.
  7. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
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  10. Laurence Ball, 1997. "Efficient Rules for Monetary Policy," NBER Working Papers 5952, National Bureau of Economic Research, Inc.
  11. Aoki, Kosuke, 2006. "Optimal commitment policy under noisy information," Journal of Economic Dynamics and Control, Elsevier, vol. 30(1), pages 81-109, January.
  12. 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.
  13. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
  14. Robert E. Hall & N. Gregory Mankiw, 1993. "Nominal Income Targeting," NBER Working Papers 4439, National Bureau of Economic Research, Inc.
  15. Laurence Ball & N. Gregory Mankiw & Ricardo Reis, 2003. "Monetary Policy for Inattentive Economies," NBER Working Papers 9491, National Bureau of Economic Research, Inc.
  16. Akerlof, George A., 2001. "Behavioral Macroeconomics and Macroeconomic Behavior," Nobel Prize in Economics documents 2001-4, Nobel Prize Committee.
  17. Laurence Ball, 2000. "Near-Rationality and Inflation in Two Monetary Regimes," Economics Working Paper Archive 435, The Johns Hopkins University,Department of Economics.
  18. James Peery Cover & Paul Pecorino, 2005. "Price and Output Stability under Price-Level Targeting," Southern Economic Journal, Southern Economic Association, vol. 72(1), pages 152–166, July.
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  20. Svensson, L-E-O, 1996. "Price Level Targeting vs Inflation Targeting : A free Lunch?," Papers 614, Stockholm - International Economic Studies.
  21. Mankiw, N Gregory, 2001. "The Inexorable and Mysterious Tradeoff between Inflation and Unemployment," Economic Journal, Royal Economic Society, vol. 111(471), pages C45-61, May.
  22. Xavier Gabaix & David Laibson, 2002. "The 6D Bias and the Equity Premium Puzzle," Harvard Institute of Economic Research Working Papers 1947, Harvard - Institute of Economic Research.
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  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. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
  26. 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.
  27. Gordon, Robert J, 1996. "The Time-varying NAIRU and its Implications for Economic Policy," CEPR Discussion Papers 1492, C.E.P.R. Discussion Papers.
  28. Michael Woodford, 2001. "Imperfect Common Knowledge and the Effects of Monetary Policy," NBER Working Papers 8673, National Bureau of Economic Research, Inc.
  29. Rotemberg, Julio J, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 517-31, October.
  30. 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.
  31. 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.
  32. 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.
  33. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
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