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Implementing Optimal Monetary Policy in New-Keynesian Models with Inertia

  • George W. Evans


    (University of Oregon Economics Department)

  • Bruce McGough

    (Oregon State University)

We consider optimal monetary policy in New Keynesian models with inertia. First order conditions, which we call the MJB-alternative, are found to improve upon the timeless perspective. The MJB-alternative is shown to be the best possible in the sense that it minimizes policymakers' unconditional expected loss, and further, it is numerically found to offer significant improvement over the timeless perspective. Implementation of the MJB-alternative is considered via construction of interest-rate rules that are consistent with its associated unique equilibrium. Following Evans and Honkapohja (2004), an expectations based rule is derived that always yields a determinate model and an E-stable equilibrium. Further, the "policy manifold" of all interest-rate rules consistent with the MJB-alternative is classified, and open regions of this manifold are shown to correspond to indeterminate models and unstable equilibria.

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Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2006-5.

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Length: 36
Date of creation: 03 Jun 2006
Date of revision:
Handle: RePEc:ore:uoecwp:2006-5
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