A Promised Value Approach to Optimal Monetary Policy
65 Pages Posted: 5 Dec 2018 Last revised: 21 Feb 2019
Date Written: 2018-12-03
This paper characterizes optimal commitment policy in the New Keynesian model using a novel recursive formulation of the central bank's infinite horizon optimization problem. In our recursive formulation motivated by Kydland and Prescott (1980), promised inflation and output gap---as opposed to lagged Lagrange multipliers---act as pseudo-state variables. Using three well known variants of the model---one featuring inflation bias, one featuring stabilization bias, and one featuring a lower bound constraint on nominal interest rates---we show that the proposed formulation sheds new light on the nature of the intertemporal trade-off facing the central bank.
Keywords: Commitment, Inflation bias, Optimal policy, Ramsey plans, Stabilization bias, Zero lower bound
JEL Classification: E61, E63, E52, E32, E62
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