What Is the Proper Perspective for
Monetary Policy Optimality?
Keynote Speech by Bennett T. McCallum

In forward-looking models for monetary policy analysis, the conditions
for full conditional optimality are not time invariant, and as a consequence imply an incentive each period for the central bank to departfrom its previous optimized plan. The conditional “commitment” plan istherefore strategically incoherent. Discretionary optimality does not havethis problem, but yields inferior performance. A “timeless perspective”
policy rule proposed by Woodford (1999, 2003) is intended to overcome
the incoherence and noncredibility of the commitment plan while yielding performance superior to that of discretionary policy behavior; thisrule has received much attention. A fourth “fully timeless” alternative
differs slightly from the timeless perspective rule; it is unambiguously
superior from an unconditional perspective but does not dominate fromthe conditional perspective. The paper discusses comparisons at somelength and briefly considers the sustainability of these policy strategies.
Keywords: Policy rules; Dynamic inconsistency; Timeless perspective
JEL Classification: C61, E52

Carnegie Mellon University (E-mail: bmccallum@cmu.edu)
I am grateful to Christian Jensen, Takushi Kurozumi, and Alexander Wolman for helpful discussions.
MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005
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13

I. Introduction
At a conference held by the Bank of Japan, with the topic of “incentive mechanisms
for economic policymakers,” it is natural to focus on incentives involving central
banks. There are two levels at which central bank incentives could be considered, theprivate level and the social level. The former focuses on the self-interest of the central
bank institution or even the personal objectives of individuals in the central bank.
This level is important, because actual policy decisions are made by purposefulindividuals or groups of individuals whose actions are strongly influenced by mattersaffecting their own income, prestige, working conditions, and so on. It seems clearthat a full understanding of policy behavior requires some attention to incentives atthis level. But it also seems clear that a truly satisfactory analysis of the implied type
would be extremely difficult, for policymakers’ objectives are in significant partconcerned with attainment and retention of policy positions, the determination ofwhich is part of a nation’s political process. Adequate treatment of this aspect of
behavior therefore requires an adequate model of the political system, including
voter behavior. And despite many admirable efforts and considerable progress, theprofession is still a long way from having a widely accepted model of that type.
Accordingly, my paper will be concerned with the second level, in which we viewthe central bank as an altruistic entity that seeks to conduct monetary policy in amanner which will enhance social welfare. Specifically, I would like to briefly revisit
the famous time-inconsistency problem introduced by Kydland and Prescott (1977),
which involves the optimizing central bank’s often-present incentive to depart fromplans made in previous periods. This is a much-studied problem that cannot becovered in its entirety, but there are some recent developments of interest that seem
to warrant discussion.
The past few years (e.g., 1999–2005) have been marked by an outpouring of
papers on the topic of optimal monetary policy, some of the more notable ones being
Clarida, Galí, and Gertler (1999), Evans and Honkapohja (2003), Giannoni andWoodford (2005), Goodfriend and King (2001), Ireland (1997), Jensen (2002), Kingand Wolman (1999), Rotemberg and Woodford (1999), Svensson (1999, 2003),
Svensson and Woodford (2005), Walsh (2003), and Woodford (1999, 2003).1 These
writers fail to agree, however, on the concept of optimality that is appropriate formonetary policy considerations. One obvious issue is whether it is desirable to use, as
the monetary policymaker’s objective function, the utility function of a representative
individual agent as specified in the analyst’s macroeconomic model. To do so would
be rather natural, when considering social welfare. This is not, however, the issue on
which the present paper is focused. Instead, the paper will be concerned with theappropriate perspective for monetary policy optimality, involving questions such as
the following: Should optimization be unconditional or conditional on prevailing
initial conditions? Should it or should it not presume some form of commitmentby the monetary authority? If so, what form? What is the nature and relevance ofWoodford’s (1999, 2003) prominent “timeless perspective” (TP) approach? These
1. Other relevant but less prominent items include Wolman (2001), Jensen (2001, 2003), Jensen and McCallum(2002), and McCallum and Nelson (2000).

14 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

What Is the Proper Perspective for Monetary Policy Optimality?

and other related matters are the focus of this paper, which presumes that the policymaker’s primary concern is with routine monetary stabilization, not a transition from,for example, a high-inflation to a low-inflation environment. It begins in Section II
with the specification of an expository example, continues in Section III with adelineation of some leading alternative approaches, and continues in Section IV witha discussion that contains much of the paper’s analysis. Section V includes a very brief
discussion of sustainability issues, and finally Section VI provides a short summary.2

II. Example Model Specification
To illustrate more clearly the various possibilities, let us consider an example based on anear-canonical model that appears very frequently in the literature. Its specification is
not satisfactory for all issues, partly because it takes the average inflation target as given,
but is useful for exposition of the particular issues at hand.3 Thus, we suppose that themonetary authority (i.e., the central bank, or CB) seeks at time t = 1 to minimize

L 1 = E 1  t −1[(t −  *)2 + yt2],
t =1

(1)

in an economy in which inflation t and the output gap yt are related by the priceadjustment relation

t = 1Et t +1 + yt + ut .

(2)

Here the output gap is measured as a fractional (or logarithmic) departure from the“natural rate” value of output that would prevail if prices were fully flexible, while  *is the CB’s inflation target value. Also, ut is a stochastic shock, reflecting some sort ofinefficiency that, for simplicity, may be taken to be white noise with mean zero.4
Note that the private-sector discount factor is denoted as 1, indicating that it could
possibly differ from that of the CB, which is . Initially, however, we assume that
1 = . The model at hand also includes an intertemporal optimizing conditionof the “expectational IS” type, but this third relation is not relevant to the policy
optimality problem at hand.5
In this linear-quadratic setup, certainty equivalence prevails, so we can utilize theLagrangian expression1 = { t −1[(t −  *)2 + yt2] + t  t −1[1t +1 + yt + ut − t ]},
t =1

(3)

2. Some of these issues have been discussed by Wolman (2001). His article is skillfully executed and clearly written,
but reaches conclusions that in some ways differ from those presented below.
3. We are, in other words, here concerned with the attainment of specified policymaker objectives, not the determination of which objectives would maximize individual welfare. The latter topic is an important one, but the considerations explored here are logically prior—that is, would continue to apply.
4. For a rationalizing discussion of this shock term, see Woodford (2003, pp. 448–455).
5. If it is included as another constraint in the optimization problem, the optimal values of the associated Lagrange
multipliers equal zero for all periods.

15and obtain the following first-order conditions:2yt +  t = 0,2(t −  *) + t −1 −2(t −  *) −

t

t

= 0,

= 0,

t = 1, 2, . . . ,(4)

t = 2, 3, . . . ,(5)

t = 1.

(6)

For all periods after the (one-period) start-up is completed, elimination of the
Lagrangian multiplier t readily yields(t −  *) + ( /)(yt − yt −1) = 0, t = 2, 3, . . . .

(7)

For the start-up period, however, (4) and (6) imply(t −  *) + ( /)yt = 0,

t = 1.

(8)

The difference between (7) and (8) arises because the latter is concerned with thetransition from prevailing initial conditions toward the stochastic steady state in which
the system tends to settle down. The length of the start-up or transition episode is only
one period in this example, because of the simplicity of model’s specification; in a more
complex model, it could be longer.

III. Alternative Perspectives
We now consider four types of policy strategy, which represent different perspectives
on the concept of optimal monetary policy. The first of these is full commitment
on the basis of existing initial conditions at t = 1; the relevant optimal rule is given
by equations (7) and (8).6 This approach is, however, dynamically inconsistent tosuch an extent that I would call it “strategically incoherent”: each time this policy isreconsidered, after the start-up period, it generates with probability one an optimality
condition that is inconsistent with the one indicated at the initiation of the policy inthe start-up period t = 1 (or whenever the strategy was most recently consulted) andthis can be recognized at time t = 1.7 This strategic incoherence manifests itself in aset of optimality conditions that are not time invariant—as indicated by equations(7) and (8).
6. In this paper, I will use the word “rule” to refer to optimality conditions; in other words, to optimal targeting
rules in the terminology of Svensson (2003). For partial disagreements with some of Svensson’s terminology andarguments, irrelevant to the issues of this paper, see McCallum and Nelson (2004).
7. It has been suggested that I simply say that the strategy is “time inconsistent.” I prefer usually to avoid that term,
however, because it is used with very different meanings by, for example, Chari and Kehoe (1990) and Woodford(2003, pp. 473, 508). For the record, Kydland and Prescott (1977) simply said “inconsistent.” It would appear
that “dynamically inconsistent” has the same meaning as time-inconsistent. Strategically incoherent strategies are
the same as those that do not possess the property of continuity (see below), but the former term emphasizes thatthe lack of continuity will be known at the outset.

16 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

What Is the Proper Perspective for Monetary Policy Optimality?

We turn next to the “discretionary” type of optimization, in other words, a fresh
calculation each period constrained only by currently existing conditions. In thiscase, condition (8) will apply to every period, t = 1, 2, . . . . There is then no problem
of strategic incoherence, if each period’s choice is based on the presumption that thedecision maker will behave the same way again in each future period. The weaknessof this strategy, as emphasized by Woodford (1999, 2003) and others, is that it fails
to influence expectations usefully and thereby results in performance in terms of
CB objectives that is often relatively poor. As a comparison of equations (7) and(8) reveals, the strategy specifies, in each period after the start-up, a condition thatis quite different from one that would prevail under commitment if the economy
were in the vicinity of its steady state. (For illustrative quantitative magnitudes, see
Woodford [1999], McCallum and Nelson [2000], Jensen [2003], and Giannoni andWoodford [2005].8 )Third, the “timeless perspective” (TP) strategy, introduced by Woodford (1999),
seeks to overcome these two problems by relying upon first-order conditions thatwould have been chosen under a commitment regime if it had been adopted in the
distant past, in other words, by implementation of condition (7) in all periods
including the start-up period.9 This approach therefore specifies a rule that is timeinvariant. Consequently, the TP policy strategy (i.e., [7] for all t = 1, 2, . . .) is not
strategically incoherent. Thus, applying (7) in any period after the start-up yields a
condition that agrees with the condition for that period that this policy strategy
specified (or would have specified) in previous periods 1, 2, . . . , − 1. This property,
which Woodford terms “continuation,” is critically important in his approach to ruledesign in two respects. First, rules that feature continuation are arguably much more
conducive to credibility—rational believability by the public—than ones that do nothave that property. Second, by viewing the rule as an ongoing strategy or process the
TP approach permits the CB to update the model used in its policymaking without
implying any departure from the prevailing rule. So it is not the case that the CB
cannot update its model when new information about the nature of the economy isdeveloped. Nevertheless, the TP rule is not “time consistent,” in the usual sense
requiring that there is no incentive for the policymaker to depart from the prescribed
condition (7) in any period. Instead, there exists an incentive in each period after thestart-up to apply the discretionary rule (8), rather than (7), since it is preferable inrelation to current conditions.10 In terms of performance, the TP policy rule gives
outcomes that are superior to discretion for most reasonable parameter values—see
McCallum and Nelson (2000)—although Blake (2001) pointed out that discretion
yields superior outcomes in some extreme cases.

8. These references actually compare discretionary and TP policies, but the differences from an unconditional
perspective are the same as for the comparison at hand.
9. Woodford’s strategy seems to be basically similar to the one suggested by King and Wolman (1999, pp. 377–380).
Dennis (2001) has shown that there are many TP strategies, since there are many periods in the past in which thestart-up could have occurred, but Woodford (2003) argues that only one is time invariant.
10. Woodford (2003, pp. 23, 473) says that the TP strategy is time consistent, but under his terminology this means
any strategy such that, if its reasoning were applied at a later date, it would result in continuation of the policy
chosen in t = 1.

17

It is, nevertheless, somewhat unclear why the TP policy, as developed by
Woodford (1999) and extended by Svensson and Woodford (2005), is not designed
to be more thoroughly “timeless.” Its optimality rule is based on conditions obtained
from a conditional optimality calculation, even though the initial conditions actually
prevailing at the policy’s start-up date t = 1 are not the ones utilized. Yet thecondition that is specified to prevail in all periods after the start-up, in other words,
in t = 2, 3, . . . , is different from the one that would be obtained from an optimality
calculation that is fully timeless, in the sense of being based on unconditional
optimality, and in that respect independent of start-up conditions. That observation
leads to a fourth perspective.
The simplest way of characterizing the fourth strategy or approach has been
described by Wolman (2001) as optimal “steady state welfare,” that is, the mostfavorable expected value of the single-period objective function when comparedacross all feasible steady states. The inflation-rate emphasis of his paper led him to
discuss non-stochastic steady states, but basically the same considerations apply to acomparison of unconditionally expected values of the loss function across stochastic
steady states. In the present context, the relevant policy rule would be the one thatminimizes the unconditional expectation E [(t −  *)2 + yt2].
Suppose, then, that policy is designed to minimize E [(t −  *)2 + yt2]. Then thepolicy rule—the optimality condition for model (2)—would be(t −  *) + ( /)(yt − 1yt −1) = 0, t = 1, 2, 3, . . . .

(9)This condition cannot be readily derived analytically, but its optimality with respect to
E [(t −  *)2 + yt2] has been established by Jensen (2001, 2003) and Blake (2001).11
More generally, that is, for other models as well as the one at hand, the fully timeless(unconditional) policy can be found by searching over candidate rules, a method
utilized by Rotemberg and Woodford (1999) and (for many years) by Taylor (1979).
In what follows, it will be convenient to refer to these four concepts of monetary
policy optimality with the following abbreviations: CC for full conditional commitment optimality, DI for discretionary optimality, TP for Woodford-King-Wolman style
timeless perspective optimality, and FT for Jensen-Blake fully timeless optimality.

IV. Evaluation
As a starting point, it is useful to note that an alternative and perhaps more appealing
way to view the FT strategy is as one that minimizes the average value, across all possible start-up period initial conditions, of the policymaker’s actual objective at t = 1,
as given in expression (1).12 In that case, by utilizing the law of iterated expectations,
we have
11. See Jensen and McCallum (2002). Neither Jensen nor Blake was able to derive (9) analytically, but Blake verified
using Maple that the condition is correct when  = 1.
12. The probability distribution of the initial conditions is taken to be that obtaining unconditionally with respect tothe process generated by the model in conjunction with the rule itself.

18 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

What Is the Proper Perspective for Monetary Policy Optimality?











E E 1  t −1[(t −  *)2 + yt2]  = E  t −1[(t −  *)2 + yt2]
t =1

t =1



=  t −1E [(t −  *)2 + yt2] = (1 −  )−1E [(t −  *)2 + yt2].
t =1

(10)

Thus, the unconditional expectation of the conditional expected value (1) is proportional to the unconditional expected value of the single-period loss function. Thisequality provides an alternative perspective for the FT criterion.
In his influential treatise, Woodford (2003, pp. 508–509) has argued that adifferent criterion, which supports the TP rule, is more appropriate than the FT
criterion (10). His argument hinges on a division of the sum in (1) into two components. The first of these pertains to “the deterministic component of the equilibrium
paths of the target variables,” and the second to “the equilibrium responses to
unexpected shocks in periods after” the start-up in t = 1. It can be seen that the TP
rule (7) implied by the latter component involves different dynamic responses toshocks, after start-up influences have worn off and conditions approximating astochastic steady state have been achieved, than those implied by the FT rule (9).13
My purpose now is to consider the relative merits of the TP and FT criteria.
To begin with, it is useful to note that when 1 and  can differ, the TP optimality
condition (obtained from the revised versions of [4]–[6]) is not (7) but instead(t −  *) + ( /)[yt − (1/ )yt −1] = 0, t = 1, 2, 3, . . . ,(7′)

of which (7) is a special case. It is apparent, then, that the two rules (7′) and (9) differ
only in that the latter presumes that the CB does not discount future outcomes
relative to present ones. Note that this difference is relevant for both transitionaland steady-state policy behavior. It would seem that for the transition episode theapplication of discounting would be inappropriate, since the start-up conditions willalmost certainly not be those for which (7) is fully optimal. That objection cannot beapplied, however, to the steady-state situation. And for the stochastic steady-state
analysis, it seems that if the CB’s preferences reflect discounting of the future, then it
would be improper to set  = 1 in (7′), as is implicitly done in (9).
Another way to make the same point is as follows. In the basic example at hand,application of (7′), both in the start-up period and thereafter, fails to be fully optimal
only because the transition from the initial conditions to the stochastic steady state is
not optimal. But this difficulty would not be present if the start-up happened to occur
when the previous period’s yt was by chance equal to zero, for then (7′) would entail
the same behavior as (8). If instead (9) were applied, it would again be true that there
would be no start-up or transitional inefficiency (since [9], too, is the same as [8] wheny 0 = 0). But in this case, the conditions ([7′] and [8]) for full optimality would not be
met by use of (9), presuming that  ≠ 1, but would be met by use of (7′).
13. In my notation, and with  * = 0, this second component is t =1  t −1[E 1(t − E1t )2 +  E1( yt − E1yt )2 ]. Because of
the influence of initial conditions, the conditional variance terms may not be the same for all t so the discounting
with  is potentially relevant.

19

The foregoing consideration suggests that I was wrong to argue in favor of the FT
criterion in my comment (McCallum [2005]) on a major paper by Svensson andWoodford (2005). This special-case consideration is based, however, on the presumption that the early periods after the initiation of the rule are of no concern to the CB.
But presumably any actual CB does in fact care about the outcomes in transition
periods, even if its main concern is the steady-state performance of the system. If t = 1
is the start-up period, then (1) is by assumption the CB’s actual objective function.
What is desired, then, is a rule that minimizes (1) subject to the constraint that it
has the property of continuity. It is natural, then, to look for a time-invariant ruleof the form
(t −  *) +

y −

1 t

y

2 t −1= 0, t = 1, 2, 3, . . . ,(11)which includes (7′) and (9) as special cases. Jensen (2003) has shown, however, thatsuch a rule will have coefficients 1 and 2 whose values depend upon the initialconditions that happen to prevail at the start-up date t = 1. But that finding implies
that the rule will not have the crucial property of continuity.
What, then, are the merits of the two candidate rules, (7′) and (9), that do feature
continuity? From the discussion above, we see that the TP condition (7′) would be
optimal if the CB did not care about the component of losses that results from astart-up in which y 0 does not equal zero. But the conditional perspective of (1) implies
that the CB does in fact care about that component, and the FT condition (9) takes
account of it—but in a fashion that does not correctly discount distant periods
relative to current periods. Thus, the TP rule (7′) performs relatively better in termsof responding to shocks (Woodford’s [2003] criterion), whereas the FT rule performs
relatively better on average with respect to transitional effects (which continue indefinitely even though [7′] and [9] differ for only one period). Neither rule, accordingly,
is entirely satisfactory. Both, however, feature continuity and under many conditions
yield outcomes superior to discretion.
Before moving on, it will be desirable to digress briefly to mention two lines ofargument that are in my opinion not useful in the present context. First, it has beensuggested to me that yt −1 and therefore initial conditions should be consideredirrelevant in models based on equation (2), since ut is the only apparent state variable.
I fully share the implied enthusiasm for minimum-state-variable formulations, but do
not agree that yt −1 is irrelevant and would argue as follows. In a model in which thepolicymaker’s behavior is specified in terms of an instrument rule, the (minimum) listof state variables is unambiguous. But when the model includes forward-looking agentsand it is specified that policy is conducted “optimally,” given the rest of the model,
the list of state variables is not immediately obvious. Instead, this list will depend upon
what policy behavior is found to be optimal. In the model of equation (2), superior
results can be obtained by the CB if it takes into account yt −1, as equations (4)–(8)illustrate. Therefore, yt −1 is a relevant state variable, if policy behavior is specified to be
optimal, and that in turn implies that initial conditions (concerning yt −1) are relevant.
Second, much of Wolman’s (2001) discussion concerns the differing steady-state
properties of policies that are analogous to the third and fourth of those considered

20 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

What Is the Proper Perspective for Monetary Policy Optimality?

above, the TP and FT policies. In his model, in which the target inflation value isderived rather than prespecified, the implied steady-state rates of inflation differ forthese two policies with the TP policy implying a zero inflation rate and the FT policy
implying a small positive rate. It can be shown, however, that this difference stems
from a model specification that many analysts might consider inappropriate.14 It stems,
to be specific, from a property of the assumed price adjustment behavior that leads toviolation of the natural-rate hypothesis concerning the output gap.15 If the setup
assumed that the prices, of those firms that are not choosing new prices in a given
period, rise at the trend rate of inflation (or the previous period’s rate of inflation) rather
than staying constant, then the model’s implication would be that the steady-state
output gap is invariant to the steady-state rate of inflation.16 This alternative formulation, which should arguably be regarded as a more rational specification of private
behavior, would then eliminate the difference in steady-state rates of inflation under
the TP and FT policies.17

V. Sustainability
A basic issue, neglected up to this point, is whether any of the policies, other thanthe discretionary and time-consistent regime implying the DI condition (8) in all
periods, are plausible since each of them involves a recurring temptation by the CB
to revert to (8), with neglect of expectational effects. In game-theoretic terms, only
policy (8) of those discussed is subgame perfect. An analytical approach to this issue
that I find appealing, partly because it clearly recognizes that atomistic private agents
do not behave strategically with respect to the (non-atomistic) CB, involves thenotion of sustainability, as developed by Chari and Kehoe (1990), applied by Ireland(1997), and recently discussed and extended by Kurozumi (2005).
Roughly speaking, a candidate policy rule is sustainable if in each period the CB
finds it more desirable (i.e., the expected value of L 1 is smaller) to continue with thisrule than to switch permanently to the discretionary rule (8).18 Kurozumi (2005) has
investigated the sustainability of equilibria that are CC optimal and found that, forrealistically calibrated values of model parameters and assumed stochastic propertiesof the shock process ut , unrealistically high values of  are required to make the CC
equilibrium sustainable. A similar result is reported to hold, moreover, for the TP
rule—and apparently the same would also be true for the FT rule. On the other
hand, Kurozumi’s (2005) calculations appear to indicate that TP and FT rules could
present attractive options for CBs to adopt when recent values of yt are close to zero.
14. See, for example, Yun (1996), Erceg, Henderson, and Levin (2000), and Christiano, Eichenbaum, and Evans (2001).
15. See equation (2), according to which different maintained values of t imply different maintained values of y t .
16. In terms of our setup, t in (1) and (2) would represent the difference between inflation and its target value, with
 * then equal to zero. In (2), the steady-state value of  would be zero, so y = 0 would be implied.
17. Both would equal zero if there were no “transaction frictions,” or more generally would equal the negative of thesteady-state real rate of return so as to imply Friedman’s (1969) optimal rate of inflation.
18. Analytically, this description is actually an implication of the Chari and Kehoe (1990) definition of sustainability,
which is based on the idea of sequentially rational equilibria under plausible information assumptions, withindividuals behaving atomistically and the CB as a leader.

21

Extensions of his calculations could be employed to determine some aspects of thesustainability of TP and FT rules for given values of yt −1 under various assumptions,and perhaps other rules of the form t −  * + ( /)( yt − yt −1) for 0 < < 1. Suchcalculations might suggest rules superior to discretionary behavior that would promise
improved performance and have relatively attractive sustainability properties, in otherwords, high probabilities that there will be no reversion to DI for many years.
I am, on the other hand, somewhat ambivalent about the appropriateness ofsustainability analysis. Because unrealistically high values of  are required for fullsustainability, some authors seem to suggest that there is something literally infeasible
about a policy that imposes (9) or (7) in each period. But that is not the case; there
are no physical constraints to prevent the CB from adopting such policies.19 Yet, if
rationality of expectations were to obtain beginning immediately in the start-up period,
the unconditional expectation (average) of the loss function (1) would in most cases
be smaller with (9) than with the discretionary rule (8).20 The legitimate objection tothis last observation is instead, I believe, that expectations of private agents may differ
from the CB’s plans for a substantial number of periods, until the public becomes
convinced that the CB is going to continue with its behavior of type (9) or (7) andagents’ forecasts come to satisfy (approximately) rational expectations. But that is an
issue concerning the transition period, and for the latter the hypothesis of rational
expectations itself should be suspect. More appropriate, arguably, is the position
taken by Lucas (1980) or Kydland and Prescott (1977) according to which therational expectations assumption is relevant only for consideration of ongoing
regimes after they have settled into stochastic steady states. Considerations ofconditional optimality require, in a dynamic setting, some alternative assumption
concerning expectation formation during any transition period that occurs between
start-up and (approximate) achievement of stochastic steady-state conditions. The
same difficulty also pertains, evidently, to game-theoretic treatments of the problem.
Thus, their results, too, are highly suspect and provide an inadequate basis fordrawing firm conclusions. Indeed, there seems to be at present no fully satisfactory
method for plausible modeling of transition periods following the start-up of a newpolicy regime.

VI. Conclusions
The foregoing sections have reviewed considerations relevant to monetary policy
optimality in economies with a forward-looking structure—that is, inclusion of atleast one structural equation that involves an expectation of some endogenous variable
that will be realized in a future period. The discussion compares properties of four typesof “optimal” monetary policy rules in the context of a near-canonical model with
Calvo-type price adjustments. The four types of rules are (CC) full commitment
conditional upon prevailing conditions; (DI) discretionary optimality representing
19. Writers in the area refer to “sustainability constraints,” but these are actually conditions pertaining to assumed
behavior (including expectation formation) of private agents, not literal constraints on CB policy.
20. See Jensen and McCallum (2002).

22 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

What Is the Proper Perspective for Monetary Policy Optimality?

period by period re-optimization; (TP) the timeless perspective form of behavior
championed by Woodford (1999, 2003); and (FT) a more “fully timeless” alternative
due to Jensen (2001, 2003) and Blake (2001) that optimizes with respect to the unconditional expectation of the CB’s objective function, which is itself the conditional
expectation of the present value of current and future losses (these being quadratic
in inflation and the output gap). The TP and FT strategies have the desirable property
of continuity, whereby a CB that reconsiders a policy plan at a later date (using thesame strategy) finds it desirable to continue with its plan. There still remains some
temptation to revert to the discretionary regime, however, when the conditions forsustainability are not met. The paper discusses several considerations pertaining to thedifference between TP and FT policy rules, concluding that both are attractive withneither dominating the other.

References

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Models,” working paper, National Institute of Economic and Social Research, London, 2001.
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pp. 783–802.
Christiano, L. J., M. Eichenbaum, and C. Evans, “Nominal Rigidities and the Effect of a Shock to Monetary
Policy,” NBER Working Paper No. 8403, National Bureau of Economic Research, 2001.
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