Should Central Banks Care about Investment?
54 Pages Posted: 6 Jun 2009
Date Written: June 5, 2009
Abstract
We ask how including endogenous capital formation into a New-Keynesian model affects optimal monetary policy. We find that the response of Ramsey optimal policy to a persistent cost-pushing shock is unconventional: In response to the shock, the central bank persistently reduces the nominal interest rate below its steady state. We find that this is due to a decrease in the natural interest rate and does not reflect a desire to choose a systematically different point on the policy frontier. However, the central bank’s tradeoff is affected in the sense that inflation stabilization can become more costly: When analyzing optimal simple rules, we find that these can imply welfare losses which substantially exceed those of Ramsey optimal policy. The reason is that active interest rate policy magnifies output fluctuations by destabilizing the capital stock. When introducing adjustment cost, our results return to standard: First, Ramsey optimal policy increases the interest rate as a response to a cost-pushing shock. Second, active policy becomes more successful in mimicking the allocation a Ramsey planner would choose.
Keywords: Ramsey optimal policy, Optimal monetary policy, Investment, Sticky prices
JEL Classification: E22, E30, E52
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy
By Lawrence J. Christiano, Martin Eichenbaum, ...
-
Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy
By Lawrence J. Christiano, Martin Eichenbaum, ...
-
An Estimated Stochastic Dynamic General Equilibrium Model of the Euro Area
By Frank Smets and Rafael Wouters
-
An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area
By Frank Smets and Rafael Wouters
-
Optimal Monetary Policy with Staggered Wage and Price Contracts
By Christopher J. Erceg, Dale W. Henderson, ...
-
Shocks and Frictions in Us Business Cycles: A Bayesian DSGE Approach
By Frank Smets and Rafael Wouters
-
Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach
By Frank Smets and Rafael Wouters
-
Shocks and Frictions in U.S. Business Cycles: A Bayesian DSGE Approach
By Frank Smets and Rafael Wouters
-
Resuscitating Real Business Cycles
By Robert G. King and Sergio T. Rebelo
-
Has Monetary Policy Become More Effective?
By Jean Boivin and Marc P. Giannoni