Optimal Targeting Regimes and Instrument Rules in the Basic New Keynesian Model

In the first chapter, the objective is to measure the value of commitment in executing monetary policies in the context of the New Keynesian model and with value that is represented by the standard quadratic welfare function containing weighted output gap and inflation variances. It is found that there is a substantial potential for improvement of welfare under commitment, but this depends on some key parameters in the model. The range of parameter calibrations most often found in the literature, however, suggests the improvements will be large. We then consider specific monetary policies akin to Taylor rules. From the optimality conditions we derive a Taylor-type rule that meets the optimal path conditions exactly. Further, we derive a form which is actually guaranteed to produce a determinate outcome the model\u27s endogenous variables and welfare. The first chapter outlined the baseline of the New Keynesian model and provided an analytical solution to measure welfare for discretion, pre-commitment and global policies. The analysis was done under the presumption that policy makers seek to maximize the standard social welfare. The second chapter measures the benefit of \u27delegating\u27 authority to the central bank to maximize other welfare functions. It is assumed that the public is convinced the central bank will maximize this particular welfare on the long run. These alternative approaches are referred as speed limit, price level targeting, and nominal income growth targeting. The chapter shows to what extent some of those approaches may provide higher welfare than when adopting the global target and how it depends on the parameters. The chapter shows also that another alternative would be to including volatility of interest rate in the welfare function. While this strategy would not often provide a higher welfare than the global target, it has the advantage of making the volatility of interest rate low, which could be beneficial when trying to avoid the lower bound issue. The third chapter investigates on how to implement the policy that will replicate the optimal paths found in previous chapter for each of the approaches. In the New Keynesian model, the most common procedure that central banks use is the Taylor rule which links the nominal interest rate with inflation and output gap. However, this raises questions about determinacy. This chapter demonstrates that when using a money rule, one which uses money as the instrument, determinacy constraints are not very different from the ones encountered with an interest rate rule. In the same vein, the adoption of a Wicksellian rule (the interest rate or money responds to the price level and output gap) does not make it easier to find a stable and unique solution