We estimate a forward-looking monetary policy reaction function for the postwar United States economy, before and after Volcker’s appointment as Fed Chairman in 1979. Our results point to substantial differences in the estimated rule across periods. In particular, interest rate policy in the Volcker-Greenspan period appears to have been much more sensitive to changes in expected in�ation than in the pre-Volcker period. We then compare some of the implications of the estimated rules for the equilibrium properties of in�ation and output, using a simple macroeconomic model, and show that the Volcker-Greenspan rule is stabilizing. I.

We examine the frequency of price changes for 350 categories of goods and services covering about 70 % of consumer spending, based on unpublished data from the BLS for 1995 to 1997. Compared with previous studies we find much more frequent price changes, with half of goods' prices lasting less than 4.3 months. Even excluding the role of temporary price cuts (sales), we find that half of goods' prices last 5.5 months or less. The frequency of price changes differs dramatically across categories. We exploit this variation to ask how inflation for "flexible-price goods" (goods with frequent changes in individual prices) differs from inflation for "sticky-price goods" (those displaying infrequent price changes). Compared to the predictions of popular sticky price models, actual inflation rates are far more volatile and transient, particularly for sticky-price goods.

The paper extends previous analysis of closed-economy inflation targeting to a small open economy with forward-looking aggregate supply and demand with some microfoundations, and with stylized realistic lags in the different transmission channels for monetary policy. The paper compares targeting of CPI and domestic inflation, strict and exible inflation targeting, and inflation-targeting reaction functions and the Taylor rule. The optimal monetary policy response to several different shocks is examined. Flexible CPI-inflation targeting stands out as successful in limiting not only the variability of CPI inflation but also the variability of the output gap and the real exchange rate. Somewhat counter to conventional wisdom, negative productivity supply shocks and positive demand shocks have similar effects on inflation and the output gap, and induce similar monetary policy responses. The model gives limited support for a so-called monetary conditions index, MCI, of the monetary-policy impact on aggregate d...

Contents 4 A Neo-Wicksellian Framework 1 1 ABasicModeloftheE#ectsofMonetaryPolicy................ 3 1.1 AnIntertemporalISRelation ...................... 4 1.2 ACompleteModel ............................ 9 2 Interest-Rate Rules and Price Stability ..................... 12 2.1 TheNaturalRateofInterest....................... 12 2.2 Conditions for Determinacy of Equilibrium ............... 18 2.3 Determinants of Inflation ......................... 32 2.4 Policy Rules for Inflation Stabilization ................. 41 3 MonetaryPolicyandInvestmentDynamics................... 45 3.1 InvestmentDemandwithStickyPrices................. 46 3.2 OptimalPrice-SettingwithEndogenousCapital............ 51 3.3 ComparisonwiththeBaselineModel .................. 56 3.4 CapitalandtheNaturalRateofInterest ................ 67 Chapter 4 A Neo-Wicksellian Framework for the Analysis of Monetary Policy We are now ready to consider the e#ects of alternative interest-ra

This paper investigates the predictions of a simple optimizing model of nominal price rigidity for the aggregate price level and the dynamics of inflation. I compare the model’s predictions with those of a perfectly competitive, flexible price ‘benchmark’ model (corresponding to the model of pricing assumed in standard real business cycle models), and evaluate how much the introduction of nominal rigidities improves the model’s fit with the data. The model’s predictions are derived using only the firms optimal pricing problem; taking as given the paths of nominal labor compensation, labor productivity, and output, I determine the implied path of prices predicted by the model. Because prices are not a stationary series, I present my results in terms of the predicted path of the price/unit labor cost ratio, where the parameters characterizing such paths are chosen to maximize the fit with the data. I find that, while the evolution of prices relative to unit labor costs is quite different from what would be predicted by the flexible-price ‘benchmark ’ model, a simple model of nominal price rigidity delivers an extremely close approximation both of the price/unit labor cost ratio and of the inflation series, even under a very simple approach to the measurement of marginal costs. Moreover, the results are robust to modifications of this measure.

The views expressed in this paper are those of the authors and do not necessarily reflect those of the Bank of England. We have benefited greatly from the comments and suggestions of Bill

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This paper discusses the short-mn tradeoffbetween inflation and unemployment. Although this tradeoff remains a necessary building block of business cycle theory, economists have yet to provide a completely satisfactory explanation for it. According to the consensus view among central bankers and monetary economists, a contractionary monetary shock raises unemployment, at least temporarily, and leads to a delayed and gradual fall in inflation. Standard dynamic models of price adjustment, however, carmot explain this pattern of responses. Reconciling the consensus view about the effects of monetary policy with models of price adjustment remains an outstanding puzzle for business cycle theorists.

It is a pleasure to be asked to comment upon Lars Svensson’s thoughtful and ambitious paper, though it raises far too many issues for me to attempt to address them all in the limited time available here. Svensson offers a thorough review of the recent scholarly literature on the conduct of monetary policy, and also reviews one of the most important recent developments in central bank practice as well, namely the evolving methodology of “inflation forecast targeting.” In my own remarks, I would like to develop further a single theme, which is the advantage of central bank commitment to a systematic approach to monetary policy. This theme also figures in Svensson’s discussion, but I believe that its consequences extend even further than he indicates.

A number of recent papers have developed dynamic macroeconomic models that incorporate rational expectations and optimizing foundations. While the theoretical motivation behind t hese models is sound, the dynamic implications of many of the specifications that assume rational expectations and optimizing behavior can be seriously at odds with t he data, for bo t h inflation and real-side variables. In a nutshell, the models imply that inflation or real spending "jump" in response to shocks, in contradiction to a host of empirical evidence that shows that both price and real-side variables exhibit gradual and "hump-shaped" responses to real and monetary shocks. For models that are intended for monetary policy analysis, these dynamic shortcomings should be considered quite serious. When monetary policy has only short-run effects on real variables, the inability to approximately capture the short-run responses of inflation or real variables to policy shocks makes a model unsuitable for pol...