Consistent Targets and Optimal Monetary Policy: Conservative Central Banker Redux
Kydland and Prescott (1977) consider the issue of the time-inconsistency of optimal policy and its source. Our paper provides additional insight on this issue. They develop a simple model of monetary policy making, where the central bank needs some commitment technique to achieve optimal monetary policy over time. Although not their main focus, they illustrate the difference between consistent and optimal policy in a sequential-decision one-period world. In our solution, the government appoints a central bank or delegates to the central bank an objective function that differs from the social welfare function. The central bank's welfare function causes the consistent policy implemented by the central bank to prove optimal for society. The optimal institutional design for the Kydland-Prescott sequential-decision one-period model requires the appointment or delegation to a completely conservative central banker.
|Date of creation:||Dec 2005|
|Date of revision:||Jan 2009|
|Publication status:||Published in International Journal of Business and Economics, April 2010, with the title "Designing Central Bank Loss Functions."|
|Note:||This paper previously circulated under the title "Consistent Targets and Optimal Monetary Policy: A Note". We presented an earlier version at Federal Reserve Bank of Boston.|
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