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Optimal Monetary Policy and Expectation Driven Business Cycles

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  • Guo, Shen

Abstract

We explore the optimal response of central bank when a news shock hits the economy, that is, agents’ optimistic expectation of an improvement in technology does not realize. Ramsey optimal policy and simple policy rules are studied in a two-sector model with price rigidities in each of non-durable and durable sector. We find that a simple policy rule reacting to the inflation rates in both non-durable and durable sector with appropriate weights can mimic the performance of the Ramsey policy closely. Another interesting result is that monetary policy plays an important role in generating expectation driven business cycles.

Suggested Citation

  • Guo, Shen, 2007. "Optimal Monetary Policy and Expectation Driven Business Cycles," MPRA Paper 1928, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:1928
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    File URL: https://mpra.ub.uni-muenchen.de/1928/1/MPRA_paper_1928.pdf
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    References listed on IDEAS

    as
    1. Chinn, Menzie D., 2000. "Before the fall: were East Asian currencies overvalued?," Emerging Markets Review, Elsevier, vol. 1(2), pages 101-126, September.
    2. Erlat, Güzin & Arslaner, Ferhat, 1997. "Measuring the Real Exchange Rate: Annual Series for Turkey," MPRA Paper 45999, University Library of Munich, Germany.
    3. Erlat, Güzin & Arslaner, Ferhat, 1997. "Measuring Annual Real Exchange Rate Series for Turkey," MPRA Paper 56396, University Library of Munich, Germany.
    4. Tarhan Feyzioglu, 1997. "Estimating the Equilibrium Real Exchange Rate; An Application to Finland," IMF Working Papers 97/109, International Monetary Fund.
    5. Martine Guerguil & Martin D Kaufman, 1998. "Competitiveness and the Evolution of the Real Exchange Rate in Chile," IMF Working Papers 98/58, International Monetary Fund.
    6. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    7. Steven A. Symansky & Peter B. Clark & Leonardo Bartolini & Tamim Bayoumi, 1994. "Exchange Rates and Economic Fundamentals; A Framework for Analysis," IMF Occasional Papers 115, International Monetary Fund.
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    Cited by:

    1. Paul Beaudry & Franck Portier, 2014. "News-Driven Business Cycles: Insights and Challenges," Journal of Economic Literature, American Economic Association, vol. 52(4), pages 993-1074, December.
    2. Fève, Patrick & Matheron, Julien & Sahuc, Jean-Guillaume, 2009. "On the dynamic implications of news shocks," Economics Letters, Elsevier, vol. 102(2), pages 96-98, February.

    More about this item

    Keywords

    News shocks; Expectation driven business cycles; Optimal monetary policy;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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