Optimal Monetary Policy
Overview of Models
- Richard Clarida, Jordi Gali, and Mark Gertler, "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, v. 37, n. 4, December, 1999, pp. 1661–1707.
- Robert G. King, "The New IS-LM Model: Language, Logic, and Limits," Federal Reserve Bank of Richmond Economic Quarterly, v. 86, n. 3, Summer 2000.
Once we finish developing the main pieces of the New IS-LM model as presented by King (2000), we turn this week to investigating the role of monetary policy in this model. Our particular interest is in determining the "optimal" monetary policy in the canonical New Keynesian / New IS-LM model. The paper by Clarida, Gali & Gertler (2000) analyzes this question in particular. Read sections 1 - 4 initially. (We will cover section 6 below, and section 7 next week.)
For an additional perspective on optimal monetary policy, see Wolman (2001). (Optional reading.)
- Alexander L. Wolman, "A Primer on Optimal Monetary Policy with Staggered Price-Setting", Federal Reserve Bank of Richmond Economic Quarterly, v. 87, n. 4, Fall 2001, pp. 27–52.
Application: Target Choice
- Henrik Jensen, "Targeting Nominal Income Growth or Inflation?," American Economic Review, v. 92, n. 4, September, 2002, pp. 928–956.
Jensen (2002) presents an application of the above framework for analysis; he asks whether targeting the growth rate of nominal income might be preferable to targeting inflation. Focus your attention on a few key issues: his justification for why a central bank might want to target nominal income growth instead of inflation, and his discussion of the magnitude of the improvement in social welfare if nominal income growth is targeted. How robust are his conclusions to changes in the specification of the economic model he uses? (Ignore the mathematical appendix but not the equations in the text; we will investigate simulations using this model in lecture.)
Prior to reading this paper, review section 6 of Clarida, et al. (1999). The "endogenous persistence" model they develop there (also called a "hybrid" model by other researchers) is the starting point for Jensen (2002).
Background
There is no formal background reading for this week, as much of what we have covered to this point will serve as background for the topics presented in the above readings. That said, if you have not yet read chapter 1 of Blinder (1998) — especially sections 2 through 4 — now would be a good time to catch up on that material.
- Alan S. Blinder, "Central Banking in Theory and Practice," MIT Press, 1998.