Robustly Optimal Monetary Policy

CEP Discussion Papers from Centre for Economic Performance, LSE

Abstract: This paper analyses optimal monetary policy in response to shocks using a model that avoidsmaking specific assumptions about the stickiness of prices, and thus the nature of the Phillipscurve. Nonetheless, certain robust features of the optimal monetary policy commitment arefound. The optimal policy rule is a flexible inflation target which is adhered to in the shortrun without any accommodation of structural inflation persistence, that is, inflation which itis costly to eliminate. The target is also made more stringent when it has been missed in thepast. With discretion on the other hand, the target is loosened to accommodate fully anystructural inflation persistence, and any past deviations from the inflation target are ignored.These results apply to a wide range of price stickiness models because the market failurewhich the policymaker should aim to mitigate arises from imperfect competition, not fromprice stickiness itself.

Keywords: Inflation persistence; optimal monetary policy; rules versus discretion; stabilization bias; inflation targeting (search for similar items in EconPapers)
JEL-codes: E5 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: Written 2007-11

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