Optimal Monetary Policy under Uncertainty

Optimal Monetary Policy under Uncertainty

Richard T. Froyen and Alfred V. Guender

Recently there has been a resurgence of interest in the study of optimal monetary policy under uncertainty. This book provides a thorough survey of the literature that has resulted from this renewed interest. The authors ground recent contributions on the ‘science of monetary policy’ in the literature of the 1970s, which viewed optimal monetary policy as primarily a question of the best use of information, and studies in the 1980s that gave primacy to time inconsistency problems. This broad focus leads to a better understanding of current issues such as discretion versus commitment, target versus instrument rules, and the merits of delegation of policy authority.

Chapter 10: The Forward-Looking Model: Additional Topics

Richard T. Froyen and Alfred V. Guender

Extract

This chapter analyzes a number of related extensions of the forwardlooking model. Our starting point is a detailed analysis of the circumstances that give rise to optimal policy from a global or timeless perspective. The timeless perspective, analyzed by Woodford (1999), Clarida, Gali and Gertler (1999) and McCallum and Nelson (2004), introduces a dynamic element into the optimal policy rule. After describing policymaking from the timeless perspective, we examine several alternative monetary policy strategies which also introduce a dynamic element to the policymaking process. Policy from the timeless perspective, while optimal, may not be feasible; policy by commitment may not be possible. As such optimal policy from the timeless perspective may serve only as the benchmark for comparisons of the performance of alternative policy scenarios. Alternative policy frameworks, examined by Svensson (1999), Woodford (1999), Vestin (2000), Jensen (2002), Walsh (2003), Söderström (2005), and Nessén and Vestin (2005), represent attempts to improve upon pure discretion, typically involving the delegation of a distinct loss function to the policymaker and an element of discretion in the execution of policy. Three of these alternative policy strategies are discussed in this chapter. They are price-level targeting, in the second section, a speed limit policy in the third section, and average inflation targeting, in the fourth section. Finally, our discussion of policy rules with a dynamic, in this case inertial, component leads us to consider an issue concerning the treatment of the policymaker’s expectations under discretion in the fifth section. OPTIMAL MONETARY...

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