Targeting Rules with Intrinsic Persistence and Endogenous Policy Inertia
Michael Hanson and
No 2006-019, Wesleyan Economics Working Papers from Wesleyan University, Department of Economics
We investigate the optimality of monetary policy targeting rules in a macroeconomic model based on explicit micro-foundations for intrinsic persistence in inflation and real output. For the corresponding social welfare loss function to be minimized by the central bank, inertia arises endogenously in both the inflation and output gap stabilization objectives. In this framework, inflation targeting closely approximates the optimal precommitment policy for empirically relevant parameter values. Alternative policy rules, such as nominal income growth targeting, “speed-limit” targeting, or price level targeting, do not performas well. Previous research has demonstrated lower social welfare losses with these alternative targeting rules; such findings are shown to be primarily a consequence of assuming the central bank minimizes a simple social loss function that is not consistent with the micro-foundations of a model with intrinsic persistence.
Keywords: Habit formation; inflation persistence; targeting rules; time consistency; institutional design of monetary policy (search for similar items in EconPapers)
JEL-codes: E52 E58 (search for similar items in EconPapers)
Pages: 35 pages
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:wes:weswpa:2006-019
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