Optimal Stabilization Policy with Flexible Prices

Aleksander Berentsen () and Christopher Waller ()

No CESifo Working Paper No. 1638, CESifo Working Paper Series from CESifo Group Munich

Abstract: We construct a dynamic stochastic general equilibrium model to study optimal monetary stabilization policy. Prices are fully flexible and money is essential for trade. Our main result is that if the central bank pursues a long-run price path, thereby controlling inflation expectations, it can improve welfare by stabilizing short-run aggregate shocks. The optimal policy involves smoothing nominal interest rates which effectively smooths consumption across states. Failure to follow a long-run price path makes any stabilization attempt ineffective.

JEL-codes: E40 E50 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2005
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