A Promised Value Approach to Optimal Monetary Policy
Abstract: 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.
File(s): File format is application/pdf https://www.federalreserve.gov/econres/feds/files/2018083pap.pdf
Part of Series: Finance and Economics Discussion Series
Publication Date: 2018-12-03
Pages: 64 pages