EconPapers    
Economics at your fingertips  
 

Optimal Monetary Policy

Aubhik Khan (), Robert G. King and Alexander Wolman ()

Review of Economic Studies, 2003, vol. 70, issue 4, 825-860

Abstract: Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two sets of frictions—costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods—we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible. In our benchmark model, there is some tendency for the monetary authority to smooth nominal and real interest rates. Copyright 2003, Wiley-Blackwell.

Date: 2003
References: Add references at CitEc
Citations: View citations in EconPapers (214) Track citations by RSS feed

Downloads: (external link)
http://hdl.handle.net/10.1111/1467-937X.00269 (application/pdf)
Access to full text is restricted to subscribers.

Related works:
Working Paper: Optimal monetary policy (2002) Downloads
Working Paper: Optimal Monetary Policy (2002) Downloads
Working Paper: Optimal monetary policy (2001) Downloads
Working Paper: Optimal monetary policy (2000) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:oup:restud:v:70:y:2003:i:4:p:825-860

Access Statistics for this article

Review of Economic Studies is currently edited by Andrea Prat, Bruno Biais, Kjetil Storesletten and Enrique Sentana

More articles in Review of Economic Studies from Oxford University Press
Bibliographic data for series maintained by Oxford University Press ().

 
Page updated 2020-08-08
Handle: RePEc:oup:restud:v:70:y:2003:i:4:p:825-860