Optimal monetary policy in a simple distorted economy

In this paper I search for an optimal con�gurations of parameters for variants of the Taylor rule by using an Accurate Second-Order Welfare based method within a fully microfounded Dynamic Stochastic model, with price rigidities, without capital accu- mulation. Money is inserted via a transaction cost function, price rigidities are modelled via quadratic cost of price adjustment. A version of the model with distortionary taxation is also explicitly tested. The model is solved up to Second Order solution. Optimal rules are obtained by maximizing a conditional welfare measure, di¤erently from what has been done in the current literature. Optimal monetary policy functions turn out to be characterized by in�ation targeting parameter lower than in empirical studies. In general, the optimal values for moentary policy parameters depend from the degree of nominal rigidities and from the role of �scal policy. When nominal rigidities are higher, optimal monetary policy becomes more aggressive towards in�ation. With a tigther �scal policy, optimal monetary policy turns out to be less in�ation-aggressive. Moreover, the results show that relying conditional welfare mea- sure avoids the problems related with �rst-order or unconditional welfare measures. Impulse Response functions based on second order model solution show a non-a¢ ne pattern when the economy is hit by shocks of di¤erent magnitude