Monetary Policy for Inattentive Economies

47 Pages Posted: 13 Feb 2003

See all articles by Laurence Ball

Laurence Ball

Johns Hopkins University - Department of Economics; National Bureau of Economic Research (NBER); International Monetary Fund (IMF)

N. Gregory Mankiw

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Ricardo Reis

London School of Economics & Political Science (LSE); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2003

Abstract

This paper is a contribution to the analysis of optimal monetary policy. It begins with a critical assessment of the existing literature, arguing that most work is based on implausible models of inflation-output dynamics. It then suggests that this problem may be solved with some recent behavioral models, which assume that price setters are slow to incorporate macroeconomic information into the prices they set. A specific such model is developed and used to derive optimal policy. In response to shocks to productivity and aggregate demand, optimal policy is price level targeting. Base drift in the price level, which is implicit in the inflation targeting regimes currently used in many central banks, is not desirable in this model. When shocks to desired markups are added, optimal policy is flexible targeting of the price level. That is, the central bank should allow the price level to deviate from its target for a while in response to these supply shocks, but it should eventually return the price level to its target path. Optimal policy can also be described as an elastic price standard: the central bank allows the price level to deviate from its target when output is expected to deviate from its natural rate.

Suggested Citation

Ball, Laurence M. and Mankiw, N. Gregory and Reis, Ricardo A.M.R., Monetary Policy for Inattentive Economies (February 2003). NBER Working Paper No. w9491. Available at SSRN: https://ssrn.com/abstract=379272

Laurence M. Ball

Johns Hopkins University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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International Monetary Fund (IMF) ( email )

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N. Gregory Mankiw (Contact Author)

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Ricardo A.M.R. Reis

London School of Economics & Political Science (LSE) ( email )

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United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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