On the Implementation of Markov-Perfect Monetary Policy
FRB Richmond Working Paper No. 09-6R
22 Pages Posted: 12 Dec 2012
Date Written: July 14, 2011
The literature on optimal monetary policy in New Keynesian models under both commitment and discretion usually solves for the optimal allocations that are consistent with a rational expectations market equilibrium, but it does not study whether the policy can be implemented given the available policy instruments. Recently, King and Wolman (2004) have provided an example for which a time-consistent policy cannot be implemented through the control of nominal money balances. In particular, they .nd that equilibria are not unique under a money stock regime and they attribute the non-uniqueness to strategic complementarities in the price-setting process. We clarify how the choice of monetary policy instrument contributes to the emergence of strategic complementarities in the King and Wolman (2004) example. In particular, we show that for an alternative monetary policy instrument, namely, the nominal interest rate, there exists a unique Markov-perfect equilibrium. We also discuss how a time-consistent planner can implement the optimal allocation by simply announcing his policy rule in a decentralized setting.
Keywords: monetary policy, Markov-perfect, determinacy, interest rate rules, money supply rules
JEL Classification: E4, E5, E6
Suggested Citation: Suggested Citation