Implementing Optimal Monetary Policy: Objectives and Rules
Economic Modelling, May 2010
30 Pages Posted: 11 Aug 2007 Last revised: 26 Dec 2010
Date Written: October 29, 2009
Abstract
The inconsistency of optimal policy comes from inconsistency between the social loss function and the economic structure. Accordingly, this paper designs a central bank loss function, which proves consistent with the economic structure. Under the designed central bank loss function discretionary policy proves optimal for social welfare. Optimal discretionary policy emerges because the implied behavioral equation is identical with that under commitment to the social loss function. Consequently, this paper also designs policy rules. To some extent, policy rules appear more basic, flexible, and operational than social and central bank loss functions, but the social loss function serves as an ultimate objective and the central bank loss function explicitly identifies the attainable targets and appropriate weight to achieve the social optimum.
Keywords: optimal policy, central bank loss functions, policy rules
JEL Classification: E420, E520, E580
Suggested Citation: Suggested Citation
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