Target Level and Variability Trade-Offs

50 Pages Posted: 23 Dec 2015

See all articles by Huiping Yuan

Huiping Yuan

Xiamen University

Stephen M. Miller

University of Nevada, Las Vegas - Department of Economics; University of Connecticut - Department of Economics

Date Written: December 22, 2015

Abstract

Kydland and Prescott (1977) observe that optimal policy proves time inconsistent because of rational expectations. This paper shows that the issue of time inconsistency also arises from fewer policy instruments than targets. Fewer instruments, as is well known, lead to the issue of target controllability (Tinbergen, 1963). Accordingly, this paper investigates these two long-standing policy issues -- target controllability and time inconsistency, using the hybrid new-Keynesian model (Clarida et al., 1999). This paper finds that to address the time inconsistency issue, policy makers must first address target controllability, and that a proper target level trade-off solves target controllability, whereas a proper relative weight between target stabilizations achieves optimal target variability trade-off and solves time inconsistency. Other main results include the following. This paper derives a necessary and sufficient condition for joint asymptotic controllability of target values. The condition, which we call the long-run target level trade-off equation, is identical under commitment and under discretion. When the time-inconsistency problem does not exist, the central bank must make the same target variability trade-offs as society desires.

Keywords: Target controllability, Time inconsistency, Optimal policy, Discretionary policy, Target level, Target variability, Trade-off

JEL Classification: E52, E58

Suggested Citation

Yuan, Huiping and Miller, Stephen M., Target Level and Variability Trade-Offs (December 22, 2015). Available at SSRN: https://ssrn.com/abstract=2707691 or http://dx.doi.org/10.2139/ssrn.2707691

Huiping Yuan (Contact Author)

Xiamen University ( email )

Xiamen, Fujian 361005
China

Stephen M. Miller

University of Nevada, Las Vegas - Department of Economics ( email )

4505 S. Maryland Parkway
Box 456005
Las Vegas, NV 89154
United States
702-895-3776 (Phone)
702-895-1354 (Fax)

HOME PAGE: http://faculty.unlv.edu/smiller/

University of Connecticut - Department of Economics

365 Fairfield Way, U-1063
Storrs, CT 06269-1063
United States

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