Structural Breaks and Optimal Monetary Policy

Fabrizio Mattesini () and Salvatore Nisticò ()

Departmental Working Papers from Tor Vergata University, CEIS

Abstract: This paper analyzes the optimal behavior of the Central Bank in an economy characterized by balanced growth. Consistently with the view of Perron (1989) and di®erently from the standard approach in DNK literature, we model the dynamics of productivity as following a trend-stationary model subject to infrequent breaks; accordingly we characterize periods of productivity slowdown as structural breaks in trend-growth. We show that breaks in trend-growth a®ect the dynamics of in°ation, the preferences of a welfare-maximizing Cen- tral Bank and optimal monetary policy. We show that in periods of productivity slowdown, optimal monetary policy should not only guarantee the appropriate response to productivity shocks, but also take into consideration the change in trend-growth in responding to cost-push shocks. Moreover, we show that during productivity slow- downs the gains from commitment are higher than during phases of high productivity growth, while the consequences of a discretionary policy, albeit optimal, may be higher in°ation instability. JEL classification: E12, E44, E52

New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2006-07

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Persistent link: http://EconPapers.repec.org/RePEc:rtv:ceiswp:237

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