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Optimal Time-Consistent Monetary Policy in a Phillips Curve World

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  • Thomas F. Cooley
  • Vincenzo Quadrini

Abstract

In this paper we study the optimal and time-consistent policy in a model economy that integrates the modern theory of unemployment with a liquidity model of monetary transmission. When the economy is subject to aggregate productivity shocks the optimal monetary policy is pro-cyclical---it increases the growth rate of money after a positive productivity shock and decreases the growth rate of money after a negative technology shock---and the model generates the Phillips Curve feature of a positive correlation between inflation and employment. We also study the long-run properties of the optimal policy under full commitment and compare it to the time-consistent policy. We show that, under some conditions, the optimal policy with commitment induces a long-run inflation rate that is higher than the long-run inflation rate in absence of policy commitment (time-consistent policy). This is in contrast to many studies that have argued that the inability of the monetary authority to commit induces a higher inflation rate.

Suggested Citation

  • Thomas F. Cooley & Vincenzo Quadrini, 1999. "Optimal Time-Consistent Monetary Policy in a Phillips Curve World," Working Papers 99-15, New York University, Leonard N. Stern School of Business, Department of Economics.
    • Handle: RePEc:ste:nystbu:99-15
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    File URL: http://w4.stern.nyu.edu/economics/docs/workingpapers/1999/99-15Cooley.pdf
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    Cited by:

    1. Stefano Neri, 2004. "Monetary policy and stock prices: theory and evidence," Temi di discussione (Economic working papers) 513, Bank of Italy, Economic Research and International Relations Area.

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