optimal monetary policy in an economy with inflation persistence abstract this paper studies optimal monetary policy in a model where inflation is persistent two types of price setters are assumed to exist one acts rationally given calvo type constraints on price setting the other type sets prices according to a rule of thumb this results in a phillips curve with both a forward looking term and a backward looking term the phillips curve nests a standard purely forward looking phillips curve as well as a standard purely backward looking phillips curve as special cases a cost push supply shock is derived from microfoundations by adding a time varying income tax and by making the elasticity of substitution between goods stochastic a central bank loss function for this model is derived from a second order taylor approximation of the household s welfare function optimal monetary policy for different relative values of the forward and backward looking terms is then analyzed for both the commitment case and the case of discretion

the new zealand approach to rules and discretion in monetary policy abstract the legislative framework under which the reserve bank of new zealand operates was changed in 1989 to one providing for a tightly constructed target rule with discretion over instrument choice the rationale for the change rests on the idea that damage to long run growth would follow if monetary policy were to pay active attention to the short run output and employment consequences of monetary policy actions the rule now in place thus prohibits monetary policy from active consideration of output and employment as objectives in their own right initial results provide tentative evidence of the benefits of the approach

optimal monetary policy in a small open economy with home bias we analyze optimal monetary policy in a small open economy characterized by home bias in consumption peculiar to our framework is the application of a ramseytype analysis to a model of the recent open economy new keynesian literature we show that home bias in consumption is a su cient condition for inducing the monetary policy maker of an open economy to deviate from a strategy of strict markup stabilization and contemplate some optimal degree of exchange rate stabilization we focus on the optimal setting of policy both in the case of rms setting prices one period in advance and in a gradual fashion subject to adjustment costs while the rst setup allows us to analytically highlight home bias as an independent source of equilibrium

do central banks respond to exchange rate movements a structural investigation abstract we estimate a small scale structural general equilibrium model of a small open economy using bayesian methods our main focus is the conduct of monetary policy in australia canada new zealand and the uk we consider generic taylor type rules where the monetary authority reacts in response to output inflation and exchange rate movements we perform posterior odds tests to investigate the hypothesis whether central banks do target exchange rates the main result of this paper is that the central banks of australia and new zealand do not whereas the bank of canada and the bank of england do include the nominal exchange rate in its policy rule this result is robust for various specification of the policy rule we also find that terms of trade movements do not contribute significantly to domestic business cycles

price stability in open economies this paper studies the conditions under which price stability is the optimal policy in a two country open economy model with imperfect competition and price stickiness special conditions on the levels of country specific distortionary taxation and the intratemporal and intertemporal elasticities of substitution need to be satisfied these restrictions apply to both cooperative and non cooperative settings most importantly we show that cooperative and non cooperative solutions do not coincide despite market completeness and producer currency pricing in this framework our analysis suggests a role for international policy coordination

average inflation targeting the analysis of this paper demonstrates that when the phillips curve has forward looking components a goal for average inflation i e targeting a j period average of one period inflation rates will cause inflation expectations to change in a way that improves the short run trade off faced by the monetary policymaker average inflation targeting is thus an example of a modified loss function which when implemented in a discretionary fashion results in more efficient outcomes from the standpoint of the true social objective inflation targeting under commitment than the discretionary pursuit of the true objective itself in purely forward looking models average inflation targeting is dominated by price level targeting but we also demonstrate in a micro founded model where the phillips curve has both forward and backward looking components that there are cases when the average inflation target provides more efficient outcomes than both ordinary one period inflation targeting and price level targeting

on the evolution of the monetary policy transmission mechanism this paper investigates whether the monetary transmission mechanism has changed or whether apparent changes are due to changes in the volatility of exogenous shocks also the question of whether any changes have been gradual or abrupt is considered a mixture innovation model is used which extends the class of time varying vector autoregressive models with stochastic volatility the advantage of our extension is that it allows us to estimate whether where when and how parameter change is occurring our empirical results indicate that the transmission mechanism the volatility of exogenous shocks and the correlations between exogenous shocks are all changing

how important is precommitment for monetary policy we quantify the welfare differential between precommitment and discretionary monetary policy in three estimated models of the u s economy by calculating the permanent deviation of inflation from target that in welfare terms is equivalent to moving from discretion to precommitment using a range of reasonable central bank preference parameters this inflation equivalent ranges from 0 05 to 3 6 percentage points with a mid point of either 0 15 or 1 1 5 percentage points depending on the model in addition to the degree of forward looking behavior we show that the existence of transmission lags and or information lags is crucial for determining the welfare gain from precommitment

inflation targeting as a monetary policy rule the purpose of the paper is to survey and discuss in ation targeting in the context of monetary policy rules the paper provides a general conceptual discussion of monetary policy rules attempts to clarify the essential characteristics of in ation targeting compares in ation targeting to other monetary policy rules and draws some conclusions for the monetary policy of the european system of central banks jel classi cation e42 e52

habit formation in consumption and its implications for monetary policy models this paper explores a monetary policy model with habit formation for consumers in which consumers utility depends in part on current consumption relative to past consumption the empirical tests developed in the paper show that one can reject the hypothesis of no habit formation with tremendous condence largely because the habit formation model captures the gradual hump shaped response of real spending to various shocks the paper then embeds the habit consumption specication in a monetary policy model and nds that the responses of both spending and inflation to monetary policy actions are signicantly improved by this modication jel d12 e52 e43

is inflation sticky abstract new keynesian sticky price models predict that monetary policy can affect real variables however they also predict that inflation can be reduced without depressing output or employment in fact bringing down inflation is costly presenting a challenge to the new keynesian model two departures from the new keynesian model predict costly disinflation one assumes sticky inflation rather than sticky prices while the other assumes less than perfectly rational expectations taking into account information from surveys of inflation expectations i find the evidence suggests that inflation is not sticky and that inflation expectations are less than perfectly rational

price level versus inflation targeting abstract this paper shows that price level targeting outperforms inflation targeting in the standard new keynesian model under the assumption that the central bank is forced to operate in an environment characterized by discretion in the benchmark case with no persistence in the shocks the commitment solution can be fully replicated intuitively price level targeting introduces history dependence and a stationary level of prices both of which are prominent features of the commitment solution

speed limit policies the output gap and optimal monetary policy in a standard new keynesian model a myopic central bank concerned with stabilizing inflation and changes in the output gap will implement a policy under discretion that replicates the optimal timeless perspective precommitment policy by stabilizing output gap changes the central bank imparts inertia into output and inflation that is absent under pure discretion even a fully optimizing i e non myopic central bank operating in a discretionary policy environment achieves better social outcomes if it focuses on inflation and changes in the output gap than are achieved under inflation targeting this abstract was borrowed from another version of this item

monetary policy and welfare in a small open economy this paper analyzes optimal monetary policy in a small open economy featuring monopolistic competition and nominal rigidities it shows that the utility based loss function for this economy can be written as a quadratic expression of domestic inflation output gap and real exchange rate the presence of an internal monopolistic distortion and a terms of trade externality drives optimal policy away from domestic inflation targeting and affects the optimal level of exchange rate volatility when domestic and foreign goods are close substitutes for each other the optimal policy rule implies lower real exchange rate volatility than a domestic inflation targeting regime the reverse is true when the elasticity of substitution between goods is low

an optimizing is lm specification for monetary policy and business cycle analysis we ask whether relations of the is lm type can sensibly be used for the aggregate demand portion of a dynamic optimizing general equilibrium model intended for analysis of issues regarding monetary policy and cyclical fluctuations the main result is that only one change the addition of a term regarding expected future income is needed to make the is function match a fully optimizing model whereas no changes are needed for the lm function this modification leads to a dynamic forward looking model of aggregate demand that is tractable and usable with a wide variety of aggregate supply specifications theoretical applications concerning price level determinacy and gradual price adjustment are included

uncovering the hit list for small inflation targeters a bayesian structural analysis we estimate underlying structural macroeconomic policy objectives of three of the earliest explicit inflation targeters within the context of a small open economy dynamic stochastic general equilibrium model we assume central banks set policy optimally such that we can reverse engineer policy objectives from observed time series data joint tests of the posterior distributions of these policy preference parameters suggest that the central banks are very similar in their overall objective none of the central banks show a concern for stabilizing the real exchange rate all three central banks share a concern for minimizing the volatility in the change in the nominal interest rate we also show that the resulting optimal policy rule responds to exchange rate movements even in the case where the central banks do not explicitly care about exchange rate stabilization this result is also corroborated by results from an alternative simple rule characterization and estimation of central bank behavior these last two findings point to the pitfalls of making inferences from the level of ad hoc simple rules about what central banks may care about

excess reserves and economic activity abstract this paper examines endogenous excess reserve holdings in the banking sector of an otherwise standard dsge environment excess reserves act as an extensive margin of bank lending that is inactive in traditional limited participation models where banks hold minimal reserves by assumption the results suggest that this extensive margin of bank lending can dampen and even overturn the standard liquidity effect of monetary contractions when the liquidity effect is overturned a monetary contraction results in an increase in output in addition the model predicts that changes in the interest rate paid on reserves can deliver large short run responses

a happy half way house medium term inflation targeting in new zealand abstract the 2002 policy targets agreement pta between the government and central bank of new zealand asks the central bank to target inflation over the medium term rather than over an annual target delegating such a medium term objective to the central bank shifts inflation targeting towards a halfway house between inflation targeting and price level targeting we show empirically that this helps time consistent policy approximate the first best commitment policy even when the government asks the central bank to weight output stabilisation differently to society we estimate the new zealand economy with a small open economy dsge model and show that the happiest halfway house is located around a two year averaging horizon at most which leads to mild improvements in monetary policy efficiency

assessing the lucas critique in monetary policy models empirical estimates of monetary policy rules suggest that the behavior of u s monetary policymakers changed during the past few decades however for that same time period statistical analyses of lagged representations of the economy such as vars often have not rejected the null of structural stability these two sets of empirical results appear to contradict the lucas critique this paper reconciles these results with the lucas critique by showing that the apparent policy invariance of reduced forms is consistent with the magnitude of historical policy shifts and the relative insensitivity of the reduced forms of plausible forward looking macroeconomic specifications to policy shifts