Abstract
We compare optimal and simple interest-rate rules. Our model features optimizing agents, monopolistic competition in both product and labor markets, and one-period nominal contracts (for wages alone or for both wages and prices) signed before shocks are known. Exact solutions ensure that we obtain correct welfare rankings. Optimal rules maximize the unconditional expected utility of the representative agent with commitment subject to the information set of the policymaker. Even with monopolistic distortions, the optimal full-information rule makes the economy mimic the hypothetical full-flexibility equilibrium. Strict versions of inflation targeting, nominal-income-growth targeting, and other such simple rules are suboptimal under both full and partial information but flexible versions are optimal under certain partial-information assumptions. Nominal-income-growth targeting dominates inflation targeting for plausible parameter values.
Original language | English |
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Pages (from-to) | 1463-1495 |
Number of pages | 33 |
Journal | Journal of Monetary Economics |
Volume | 52 |
Issue number | 8 |
DOIs | |
Publication status | Published - 2005 Nov |
Externally published | Yes |
Keywords
- Inflation targeting
- Interest-rate rule
- Nominal-income-growth targeting
- Optimal monetary policy
- Wage and price contracts
ASJC Scopus subject areas
- Finance
- Economics and Econometrics