Unconventional Policy Instruments in the New Keynesian Model

35 Pages Posted: 26 Apr 2016

See all articles by Zineddine Alla

Zineddine Alla

Sciences Po

Raphael A. Espinoza

International Monetary Fund (IMF)

Atish R. Ghosh

International Monetary Fund (IMF) - Policy Development and Review Department

Date Written: March 2016

Abstract

This paper analyzes the use of unconventional policy instruments in New Keynesian setups in which the ‘divine coincidence' breaks down. The paper discusses the role of a second instrument and its coordination with conventional interest rate policy, and presents theoretical results on equilibrium determinacy, the inflation bias, the stabilization bias, and the optimal central banker's preferences when both instruments are available. We show that the use of an unconventional instrument can help reduce the zone of equilibrium indeterminacy and the volatility of the economy. However, in some circumstances, committing not to use the second instrument may be welfare improving (a result akin to Rogoff (1985a) example of counterproductive coordination). We further show that the optimal central banker should be both aggressive against inflation, and interventionist in using the unconventional policy instrument. As long as price setting depends on expectations about the future, there are gains from establishing credibility by using any instrument that affects these expectations.

Keywords: Unconventional monetary policy, equilibrium indeterminacy, stabilization bias, inflationary bias, instrument, instruments, inflation, monetary policy, interest, Monetary Policy (Targets, and Effects), All Countries,

JEL Classification: E52, E58, F31

Suggested Citation

Alla, Zineddine and Espinoza, Raphael A. and Ghosh, Atish R., Unconventional Policy Instruments in the New Keynesian Model (March 2016). IMF Working Paper No. 16/58, Available at SSRN: https://ssrn.com/abstract=2770293

Zineddine Alla (Contact Author)

Sciences Po ( email )

27 rue Saint-Guillaume
Paris Cedex 07, 75337
France

Raphael A. Espinoza

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

HOME PAGE: http://oxford.academia.edu/RaphaelEspinoza

Atish R. Ghosh

International Monetary Fund (IMF) - Policy Development and Review Department ( email )

700 19th St. NW
Washington, DC 20431
United States

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