Optimal Monetary Policy with Price and Wage Rigidities

In this paper, I search for an optimal configuration of parameters for variants of the Taylor rule by using an accurate second‐order welfare‐based method within a fully microfounded dynamic stochastic model, with price and wage rigidities, without capital accumulation. A version of the model with distortionary taxation is also explicitly tested. The model is solved up to second‐order solution. Optimal rules are obtained by maximizing a conditional welfare measure, differently from what has been done in the current literature. Optimal monetary policy functions turn out to be characterized by inflation targeting parameter lower than in empirical studies. In general, the optimal values for monetary policy parameters depend on the degree of nominal rigidities and on the role of fiscal policy. When nominal rigidities are higher, optimal monetary policy becomes more aggressive to inflation. With a tighter fiscal policy, optimal monetary policy turns out to be less aggressive to inflation. Impulse‐response functions based on second‐order model solution show a non‐affine pattern when the economy is hit by shocks of different magnitude .     

Monetary policy and noise traders: A welfare analysis

This paper studies the choice of monetary policy regime in a small open economy with noise traders in forex markets. We focus on two simple rules: fixed exchange rates and inflation targeting. We contrast the above two rules against optimal policy with commitment under productivity shocks. In general, the presence of noise traders increases the desirability of a fixed exchange rate regime. We also evaluate the welfare impact of Tobin taxes in this milieu. These taxes help unambiguously in the absence of productivity shocks; their welfare impact under productivity shocks depends on the monetary regime in place and trade elasticity between domestic and foreign goods.     

Monetary Policy Rules for a Small Open Economy

In this paper, the optimal choice of a monetary target is investigated for a small open economy that is subject to foreign monetary policy shocks. In contrast to large parts of the literature, pegging the exchange rate is never the best policy choice for the small open economy in our model. Instead, monetary targeting and, depending on the parameter combination, producer price index targeting come closest to the optimal policy rule in terms of welfare. Generally, the welfare performance of the simple targeting rules under consideration hinge critically on the degree of pass-through in the home economy and in the rest of the world.     

通货膨胀目标制并不能解决我国货币政策低效率问题——一个基于政策时滞和扰动冲击的研究

本文在一个引入时滞、政策传导扰动和中介目标的货币政策模型中，分析了通货膨胀目标制的实施与货币政策效率之间的关系。我们发现，由于货币政策的时滞和货币政策传导机制的不畅，中央银行无法及时地对经济中的扰动做出正确的估计，尽管可以利用中间目标变量和其他参考变量的实际值对目标值的偏离所给出的信息来适当调整货币政策，但仍然无法对冲击及时做出正确的响应；再加上中央银行货币政策执行中的财政占优、金融占优和外部占优问题，使得中央银行无法执行其意愿的政策，因此通货膨胀目标制的引入无助于解决货币政策的低效率问题。     

Animal spirits and optimal monetary policy design in the presence of labour market frictions

Using a New Keynesian DSGE model with labour market frictions, we compare outcomes for backward-looking animal spirits expectations with rational expectations after technology and demand shocks. For optimal monetary policy, major differences arise only for technology shocks, and discretionary policy performs better than commitment policy under animal spirits expectations. If Taylor rule parameters are chosen to best replicate optimal monetary policy outcomes, inflation targeting is only appropriate for technology shocks, particularly for large labour frictions, while targeting only economic activity is appropriate for demand shocks. Fault tolerance analysis shows high costs from failing to identify true animal spirits expectations and technology shocks.     

The unbearable tightness of being in a monetary union: Fiscal restrictions and regional stability

We study how constrained fiscal policy can affect macroeconomic stability and welfare in a two-region model of a monetary union with sticky prices and distortionary taxation. Both government spending and taxes can be used to stabilize regional variables; however, the best welfare outcome is obtained under some tax variability and constant regional inflations. We use a variety of rules to characterize constrained fiscal policy and find that strict fiscal rules coupled with a monetary policy that targets union-wide inflation result in regional inflation stability and the welfare costs of such rules are not as unbearable as one would expect. Fiscal authorities can enhance welfare by targeting the regional output gap, while targeting regional inflation is less successful since inflation stability is guaranteed by the central bank.     

OPTIMAL MONETARY POLICY WITH THE STICKY INFORMATION MODEL OF PRICE ADJUSTMENT: INFLATION OR PRICE‐LEVEL TARGETING?

I investigate the optimal monetary policy in a New Keynesian macroeconomic framework with the sticky information model of price adjustment. The model is solved for optimal policy, and welfare implications of three alternative monetary policy regimes under this optimal policy are compared when there is a cost‐push shock to the economy. These monetary policy regimes are the unconstrained policy, price‐level targeting and inflation targeting regimes. The results illustrate that optimal policy depends on the degree of price stickiness and the persistence of the shock. Inflation targeting emerges as the optimal policy if prices are flexible enough or the shock is persistent enough. However, the unconstrained policy or price‐level targeting might be preferable to inflation targeting if prices are not very flexible and the shock is not very persistent. The results also show that as prices become more flexible, the welfare loss usually gets bigger.     

The effects of fiscal spending shocks on the performance of simple monetary policy rules

We examine the effects of fiscal shocks on the performance of alternative monetary policy rules in a small dynamic general equilibrium framework. We explicitly consider the interaction between fiscal and monetary policy rules which may be present in the real world. We use a simple specification for the fiscal policy rule and various specifications for the (simple) monetary policy rule. Our analysis suggests that some form of flexible inflation targeting regime would perform well in response to fiscal shocks compared to other forms of policy regimes.     

Optimal choice of monetary policy instruments under velocity and fiscal shocks

This paper, in the spirit of Poole [Poole, William, 1970. The Optimal Choice of Monetary Policy Instruments in a Simple Macro Model. Quarterly Journal of Economics, 84, 192–216.], studies how differently monetary and fiscal shocks influence the appropriate choice of the monetary policy regime. Velocity shocks are introduced by embedding a stochastic cash-in-advance constraint within the New Keynesian framework. In addition to optimal policy under discretion, three classic rules, interest rate targeting, monetary targeting, and the Taylor rule are ranked under both fiscal and velocity shocks. The non-stationarity of prices under the Taylor rule makes it inferior to the other rules under which prices are stationary. Monetary targeting, by stabilizing aggregate demand under fiscal shocks, outperforms interest rate targeting, while the latter provides a better insulation against velocity shocks. Monetary targeting (under fiscal shocks) and interest rate targeting (under velocity shocks) even outperform the optimal policy under discretion for sufficiently high intertemporal elasticities of consumption substitution.     

Financial market imperfections and monetary policy strategy

In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank applying the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if interest rate pass-through is incomplete, the central bank can use a narrow monetary aggregate and the discount interest rate as independent and complementary policy instruments to reinforce the credibility of its announcements and the role of inflation target as a nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman's k-percent money growth rule, which can generate dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.     

Foreign output shock in small open economies: A welfare evaluation of monetary policy regimes

We examine the impact of negative foreign output shocks, which entail negative demand side effects by lowering exports and positive supply side effects by lowering oil prices, on the welfare of non-oil producing, small open economies under five exchange rate and monetary policy regimes. We use a dynamic stochastic general equilibrium model with parameter values calibrated for Hong Kong, Israel, Singapore, South Korea and Taiwan. We find that welfare levels among the five policy regimes depend on the economy's share of oil imports in world oil consumption. Hong Kong, Singapore and Israel, which have smaller shares, maximize welfare under the Taylor rule, which targets both CPI inflation and real output. South Korea, with higher shares, and Taiwan, with more rigid prices, maximize welfare under real output targeting. CPI inflation targeting, nominal output growth targeting and fixed exchange rate regimes generate lower welfare. However, optimal monetary policy, which generates the highest welfare, gives greater weight on real output than CPI inflation.     

A comparison of optimal policy rules prior to and during inflation targeting: empirical evidence from Bank of Canada

We examine policy rules that are consistent with inflation targeting (IT) framework in a small macroeconomic model of the Canadian economy. We set up an optimal linear regulator problem and derive policy rules to compare the dynamics of pre-IT and IT eras. We find that while the optimal monetary policy rule in the pre-IT period is best described with a loss function that attaches equal weight to price stability, financial stability and output stability; the IT era is dominated by the price stability objective followed by the financial stability and output stability, consecutively. Moreover, we do not find an explicit role for exchange rate stability in the objective function of the Bank of Canada for both monetary policy eras. We, then, compare the properties of the derived optimal rules with those of an ad hoc Taylor rule for the IT period. In response to inflationary shocks, Taylor rule brings down inflation rates more quickly compared to the derived policy rules, but at the cost of a higher sacrifice ratio and more volatile interest rates.     

Monetary policy and commodity terms of trade shocks in emerging market economies

Commodity terms of trade shocks have continued to drive macroeconomic fluctuations in most emerging market economies. The volatility and persistence of these shocks have posed great challenges for monetary policy. This study employs a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model to evaluate the optimal monetary policy responses to commodity terms of trade shocks in commodity dependent emerging market economies. The model is calibrated to the South African economy. The study shows that CPI inflation targeting performs relatively better than exchange rate targeting and non-traded inflation targeting both in terms of reducing macroeconomic volatility and reducing the losses of a non-benevolent central bank. However, macroeconomic stabilisation comes at a cost of increased exchange rate volatility. The results suggest that the appropriate response to commodity induced exogenous shocks is to target CPI inflation.     

Do asymmetries matter for European monetary policy?

In this paper we analyze the impact of economic and institutional (ECB decision rules) asymmetries on the effectiveness of monetary policy in Euroland. We consider a model where asymmetric shocks and divergent propagation of shocks in output and inflation are potential causes of tensions within the ECB concerning the conduct of common monetary (interest rate) policy. Welfare implications of the alternative decision procedures are discussed.     

Oil shocks and monetary policy rules in emerging economies

We examine the effects of shocks in the oil market on key macroeconomic variables in small open economies using a dynamic stochastic general equilibrium model with sticky prices and imperfect competition under different monetary policy rules. The numerical solutions show that the types of exchange rate regimes and monetary policies could partly explain the trends in macroeconomic volatilities considering negative shocks to oil supply (Hamilton, 1983) and positive shocks to oil demand (Kilian, 2009). These findings are confirmed in vector autoregressive responses for Chile and Israel with inflation targeting under flexible exchange regimes and Hong Kong with fixed regime.     

Optimal monetary policy in a Phillips-curve world

In this paper, we study optimal monetary policy in a model that integrates the modern theory of unemployment with a liquidity model of monetary transmission. Two policy environments are considered: period-by-period optimization (time consistency) and full commitment (Ramsey allocation). When the economy is subject to productivity shocks, the optimal policy is pro-cyclical. We also characterize the long-term properties of monetary policy and show that with commitment the optimal inflation rate is inversely related to the bargaining power of workers. Both results find empirical support in the data.     

Monetary policy rules for financially vulnerable economies

One distinguishable characteristic of emerging market economies is that they are not financially robust. These economies are incapable of smoothing out large external shocks, as sudden capital outflows imply abrupt swings in the real exchange rate. Using a small open-economy model, this paper examines alternative monetary policy rules for economies with different degrees of liability dollarization. The paper answers the question of how efficient it is to use inflation targeting (IT) under high liability dollarization. Our findings suggest that it might be optimal to follow a nonlinear policy rule that defends the real exchange rate in a financially vulnerable economy.     

Evaluating inflation targeting as a monetary policy objective for India

This study formulates a small open economy model for India with exchange rate as a prominent channel of monetary policy. The model is estimated using the Instrumental Variable-Generalized Methods of Moments (IV-GMM) estimator and evaluated through simulations. This study compares different cases of domestic and CPI inflation targeting, strict and flexible inflation targeting, and simple Taylor type rules. The analysis highlights the unsuitability of simple Taylor-type monetary rules in stabilizing the Indian economy and suggests that discretionary optimization works better in stabilizing this economy. There seems to be a trade-off between output gap stabilization and exchange rate stabilization in flexible domestic inflation targeting and CPI inflation targeting respectively. However, flexible domestic inflation targeting seems a better alternative from an overall macro stabilization perspective in India where financial markets are still not sufficiently integrated to ensure quick transmission of interest rate impulses and existence of rigidities in the economy.     

Optimal price‐level drift under commitment in the canonical New Keynesian model

Abstract In both the canonical and many extended versions of the New Keynesian model, optimal monetary policy under commitment implies price‐level stationarity as long as expectations are rational. We show that this is no longer the case if the central bank and private agents make decisions before observing current shocks. The optimal amount of price‐level drift in response to unexpected innovations to inflation is quantitatively important. This result has important implications for monetary policy, including the design of the optimal loss function for the central bank if it cannot commit to its future policies.     

Public debt indexation and denomination with an independent central bank

This paper examines the interaction between public debt management and the design of monetary institutions. The analysis shows that delegation of monetary policy to an independent central bank is more effective in containing inflationary expectations than the use of foreign currency or inflation-indexed debt. If delegation of monetary policy is viable, the optimal policy is to issue nominal debt. This increases the sensitivity of taxes and output to unexpected inflation, thus minimizing the inflation needed to offset supply shocks. Evidence on central bank independence, debt composition and output variability suggests that the normative argument has some positive content.