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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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  1. Damjanovic, Tatiana & Damjanovic, Vladislav & Nolan, Charles, 2008. "Unconditionally optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 491-500, April.
  2. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  3. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
  4. Jess Benhabib & Stefano Eusepi, 2005. "The design of monetary and fiscal policy: a global perspective," Proceedings, Federal Reserve Bank of San Francisco.
  5. Andrew Blake, 2001. "A Timeless Perspective on Optimality in Forward-Looking Rational Expectations Models," NIESR Discussion Papers 188, National Institute of Economic and Social Research.
  6. 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.
  7. Bruce McGough & George Evans, 2004. "Optimal Constrained Interest Rate Rules," Computing in Economics and Finance 2004 134, Society for Computational Economics.
  8. Bennett T. McCallum & Edward Nelson, 1998. "Performance of operational policy rules in an estimated semi-classical structural model," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  9. Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies.
  10. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers 2002-11, University of Oregon Economics Department, revised 01 Feb 2004.
  11. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September.
  12. Andrew Levin & Volker Wieland & John C. Williams, 2003. "The Performance of Forecast-Based Monetary Policy Rules Under Model Uncertainty," American Economic Review, American Economic Association, vol. 93(3), pages 622-645, June.
  13. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
  14. Lars E.O. Svensson, 2005. "Monetary Policy with Judgment: Forecast Targeting," NBER Working Papers 11167, National Bureau of Economic Research, Inc.
  15. Galí, Jordi & Gertler, Mark, 1999. "Inflation Dynamics: A Structural Economic Analysis," CEPR Discussion Papers 2246, C.E.P.R. Discussion Papers.
  16. Jordi Gali & Mark Gertler, 2000. "Inflation Dynamics: A Structural Econometric Analysis," NBER Working Papers 7551, National Bureau of Economic Research, Inc.
  17. Jensen, Christian & McCallum, Bennett T., 2002. "The non-optimality of proposed monetary policy rules under timeless perspective commitment," Economics Letters, Elsevier, vol. 77(2), pages 163-168, October.
  18. McCallum, Bennett-T, 2005. "What Is the Proper Perspective for Monetary Policy Optimality?," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 23(S1), pages 13-24, October.
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