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Optimal Monetary Policy in an Imperfect World


  • Andrew Levin
  • Eric Swanson


We compute the optimal Ramsey policy in a New Keynesian model where the steady state suffers from monopolistic and tax distortions. We show that the optimal monetary policy in this environment displays asymmetric responses to shocks to optimally inflate the economy (slightly) at times when it would be most beneficial to the representative agent to do so. We show that the ergodic mean of inflation under the optimal policy is slightly positive (not zero), that the ergodic mean of the output gap is slightly positive, and that welfare is actually higher than in a flexible-price version of the economy, because of the monetary authority's ability to slightly offset, in ergodic mean, the steady-state distortions in the economy

Suggested Citation

  • Andrew Levin & Eric Swanson, 2004. "Optimal Monetary Policy in an Imperfect World," Computing in Economics and Finance 2004 235, Society for Computational Economics.
  • Handle: RePEc:sce:scecf4:235

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    References listed on IDEAS

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    Cited by:

    1. Frank Smets & Raf Wouters, 2005. "Welfare analysis of non-fundamental asset price and investment shocks: implications for monetary policy," BIS Papers chapters,in: Bank for International Settlements (ed.), Investigating the relationship between the financial and real economy, volume 22, pages 146-65 Bank for International Settlements.

    More about this item


    perturbation; welfare analysis; second-order approximation; Lagrangean; Ramsey;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy


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