Is Optimal Monetary Policy Always Optimal?

CFS Working Paper No. 510

43 Pages Posted: 19 Aug 2015

See all articles by Troy Davig

Troy Davig

Federal Reserve Bank of Kansas City

Refet S. Gurkaynak

Bilkent University - Department of Economics

Multiple version iconThere are 4 versions of this paper

Date Written: July 28, 2015

Abstract

No. And not only for the reason you think. In a world with multiple inefficiencies the single policy tool the central bank has control over will not undo all inefficiencies; this is well understood. We argue that the world is better characterized by multiple inefficiencies and multiple policy makers with various objectives. Asking the policy question only in terms of optimal monetary policy effectively turns the central bank into the residual claimant of all policy and gives the other policymakers a free hand in pursuing their own goals. This further worsens the tradeoffs faced by the central bank. The optimal monetary policy literature and the optimal simple rules often labeled flexible inflation targeting assign all of the cyclical policymaking duties to central banks. This distorts the policy discussion and narrows the policy choices to a suboptimal set. We highlight this issue and call for a broader thinking of optimal policies.

Keywords: Central Banking, Monetary Policy, Fiscal Policy, Optimal Policy, Optimal Policy Mix

JEL Classification: E61, E52, E58, E02

Suggested Citation

Davig, Troy and Gurkaynak, Refet S., Is Optimal Monetary Policy Always Optimal? (July 28, 2015). CFS Working Paper No. 510. Available at SSRN: https://ssrn.com/abstract=2645699 or http://dx.doi.org/10.2139/ssrn.2645699

Troy Davig

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

Refet S. Gurkaynak (Contact Author)

Bilkent University - Department of Economics ( email )

06533 Ankara
Turkey

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