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

We examine to what extent variants of inflation-forecast targeting can avoid stabilization bias, incorporate history-dependence, and achieve determinacy of equilibrium, so as to reproduce a socially optimal equilibrium. We also evaluate these variants in terms of the transparency of the connection with the ultimate policy goals and the robustness to model perturbations. A suitably designed inflation-forecast targeting rule can achieve the social optimum and at the same time have a more transparent connection to policy goals and be more robust than competing instrument rules.

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 investigates the implications of noisy information regarding the measurement of economic activity for the evaluation of monetary policy. A common implicit assumption in such evaluations is that policymakers observe the current state of the economy promptly and accurately and can therefore adjust policy based on this information. However, in reality, decisions are made in real time when there is considerable uncertainty about the true state of affairs in the economy. Policy must be made with partial information. Using a simple model of the U.S. economy, I show that failing to account for the actual level of information noise in the historical data provides a seriously distorted picture of feasible macroeconomic outcomes and produces inefficient policy rules. Naive adoption of policies identified as efficient when such information noise is ignored results in macroeconomic performance worse than actual experience. When the noise content of the data is properly taken into account, policy reactions are cautious and less sensitive to the apparent imbalances in the unfiltered data. The resulting policy prescriptions reflect the recognition that excessively activist policy can increase rather than decrease economic instability.

The zero lower bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. We use the FRB/US model to quantify the effects of the bound on macroeconomic stabilization and to explore how policy can be designed to minimize these effects. During particularly severe contractions, open-market operations alone may be insufficient to restore equilibrium; some other stimulus is needed. Abstracting from such rare events, if policy follows the Taylor rule and targets a zero inflation rate, there is a significant increase in the variability of output but not inflation. However, a simple modification to the Taylor rule yields a dramatic reduction in the detrimental effects of the zero bound. Keywords: monetary policy, macroeconometric models, liquidity trap 1 We would like to thank Marvin Goodfriend, Donald Kohn, David Lebow, Brian Madigan, Athanasios Orphanides, Michael Prell, David Small, David Stockton, Peter Tinsley, Volker Wiela...

This paper examines the implications of recent research on monetary policy rules for practical monetary policy making, with special emphasis on strategies for setting interest rates by the European Central Bank (ECB). The paper draws on recent research and new simulations of a large open economy model to assess the efficiency of a simple benchmark rule in comparison with other proposed rules. The paper stresses new results on the robustness of monetary policy rules in which each rule that is optimal or good according to one model or researcher is tested for robustness by other researchers using different models. Because of the large increase in the number of economists focussing on econometric evaluation of monetary policy rules for the interest rate instrument and because of the parallel increase in the variety of models being developed for this purpose, much more evidence is becoming available on the robustness of simple monetary policy rules for the interest rate than ever before.

Inflation targeting is a monetary-policy strategy that is characterized by an announced numerical inflation target, an implementation of monetary policy that gives a major role to an inflation forecast and has been called forecast targeting, and a high degree of transparency and accountability. It was introduced in New Zealand in 1990, has been very successful in terms of stabilizing both inflation and the real economy, and has, as of 2010, been adopted by about 25 industrialized and emerging-market economies. The chapter discusses the history, macroeconomic effects, theory, practice, and future of inflation targeting.

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