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The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy

Huiping Yuan () and Stephen Miller ()

No 910, Working Papers from University of Nevada, Las Vegas , Department of Economics

Abstract: This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the social loss function cannot serve as a direct loss function for the central bank. Accordingly, we employ implementation theory to design a central bank loss function (mechanism design) with consistent targets, while the social loss function serves as a social welfare criterion. That is, with the correct mechanism design for the central bank loss function, optimal policy and consistent policy become identical. In other words, optimal policy proves implementable (consistent).

Keywords: Optimal policy; Consistent policy; Implementation theory (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2009-03
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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