A Promised Value Approach to Optimal Monetary Policy

Timothy Hills, Taisuke Nakata and Takeki Sunakawa

Oxford Bulletin of Economics and Statistics, 2021, vol. 83, issue 1, 176-198

Abstract: This paper characterizes optimal commitment policy in the New Keynesian model using a recursive formulation of the central bank's infinite‐horizon optimization problem in which promised inflation and output gap – as opposed to lagged Lagrange multipliers – act as pseudo‐state variables. Our recursive formulation is motivated by (Kydland, F. and Prescott, E. C. (1980). Journal of Economic Dynamics and Control Vol. 2, pp. 79–91). Using three well‐known variants of the model – one featuring inflation bias, one featuring stabilization bias and one featuring a lower bound constraint on nominal interest rates – we show that the proposed formulation sheds new light on the nature of the intertemporal trade‐off facing the central bank.

Date: 2021
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https://doi.org/10.1111/obes.12401

Related works:
Working Paper: A Promised Value Approach to Optimal Monetary Policy (2020)
Working Paper: A Promised Value Approach to Optimal Monetary Policy (2018)
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