Optimal Choice of Monetary Policy Instruments Under Velocity and Fiscal Shocks

Rajesh Singh and Chetan Subramanian

Staff General Research Papers Archive from Iowa State University, Department of Economics

Abstract: This paper, in the spirit of Poole [Poole, William, 1970. The Optimal Choice of Monetary Policy Instruments in a Simple Macro Model. Quarterly Journal of Economics, 84, 192–216.], studies how differently monetary and fiscal shocks influence the appropriate choice of the monetary policy regime. Velocity shocks are introduced by embedding a stochastic cash-in-advance constraint within the New Keynesian framework. In addition to optimal policy under discretion, three classic rules, interest rate targeting, monetary targeting, and the Taylor rule are ranked under both fiscal and velocity shocks. The non-stationarity of prices under the Taylor rule makes it inferior to the other rules under which prices are stationary. Monetary targeting, by stabilizing aggregate demand under fiscal shocks, outperforms interest rate targeting, while the latter provides a better insulation against velocity shocks. Monetary targeting (under fiscal shocks) and interest rate targeting (under velocity shocks) even outperform the optimal policy under discretion for sufficiently high intertemporal elasticities of consumption substitution.

JEL-codes: E32 E42 E52 (search for similar items in EconPapers)
Date: 2009-06-08
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Published in Economic Modeling 2009, vol. 26 no. 5, pp. 865-877

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Persistent link: https://EconPapers.repec.org/RePEc:isu:genres:31612

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