Optimal Operational Monetary Policy in the Christiano-Eichenbaum-Evans Model of the U.S. Business Cycle

Stephanie Schmitt-Grohe and Martín Uribe ()

No 10724, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper identifies optimal interest-rate rules within a rich, dynamic, general equilibrium model that has been shown to account well for observed aggregate dynamics in the postwar United States. We perform policy evaluations based on second-order accurate approximations to conditional and unconditional expected welfare. We require that interest-rate rules be operational, in the sense that they include as arguments only a few readily observable macroeconomic indicators and respect the zero bound on nominal interest rates. We find that the optimal operational monetary policy is a real-interest-rate targeting rule. That is, an interest-rate feedback rule featuring a unit inflation coefficient, a mute response to output, and no interest-rate smoothing. Contrary to existing studies, we find a significant degree of optimal inflation volatility. A key factor driving this result is the assumption of indexation to past inflation. Under indexation to long-run inflation the optimal inflation volatility is close to zero. Finally, we show that initial conditions matter for welfare rankings of policies.

JEL-codes: E52 E61 (search for similar items in EconPapers)
Date: 2004-09
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Note: EFG ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (94)

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Working Paper: Optimal Operational Monetary Policy in the Christiano-Eichenbaum-Evans Model of the US Business Cycle (2004)
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