The evolution of research on monetary policy over the past two decades has been dramatic. The 1980's through the mid-1990's were dominated by work building on the insights of Kydland and Prescott, employing the notion of dynamic consistency to offer a theory of monetary policy, one in which discretionary policy by central banks led to socially costly inflation. Researchers studied the nature of the time inconsistency of monetary policy and developed solutions, ranging from appointing conservatives, to developing incentive contracts, to imposing inflation targets. Whether central bankers learned, in the words of Ben McCallum, to "just do it," or the nature of the incentives they faced changed, inflation was reduced in the industrialized economies during the 1980's and early 1990's. In the low-inflation environment since, central banks have, in the eyes of many monetary economists, changed from a source of (often) politically induced inflation to maximizers of social welfare. This shift has opened new and productive collaborations between academic economists and central bank economists interested in issues of monetary policy design. Much of this work builds on the basic foundations provided by the marriage of dynamic stochastic general equilibrium models, with their emphasis on optimizing behavior by economic agents and careful attention to budget constraints and equilibrium conditions, with simple models of price stickiness. Early contributors to these foundations include Yun (1996), Goodfriend and King (1997), and Rotemberg and Woodford (1997). The resulting framework for macroeconomic analysis, in its simplest form, boils down to an expectational IS curve, an inflation adjustment equation, and a specification of monetary policy in terms of either an objective function or a rule for setting the nominal rate of interest.
What accounts for the significant real effects of monetary policy shocks? And what accounts for the persistent and hump shaped responses of output and inflation in response to such shocks? These questions are investigated in a model that incorporates labor market search, habit persistence, sticky prices, and policy inertia. While habit persistence and price stickiness are important for the hump shaped output response and the long, drawn out inflation response, respectively, labor market frictions increase the output response and reduce the inflation response relative to an otherwise similar model based on a Walrasian labor market. Significantly, policy inertia itself is found to be the most important factor in accounting for the magnitude of the output effects of policy shocks in the model. JEL: E52, E58, J64 * Department of Economics, University of California, Santa Cruz, CA 95064, walshc@ucsc.edu. I would like to thank the two referees, seminar participants at UC Davis, UC Santa Barbara, the University of Hawaii, the University of British Columbia, and the Swiss National Bank for helpful comments on earlier versions of this and related research.
Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. In a standard New Keynesian model, a myopic central bank concerned with stabilizing inflation and changes in the output gap will implement a policy under discretion that replicates the optimal, timeless perspective, precommitment policy. By stabilizing output gap changes, the central bank imparts inertia into output and inflation that is absent under pure discretion. Even a fully optimizing (i.e., non-myopic) central bank operating in a discretionary policy environment achieves better social outcomes if it focuses on inflation and changes in the output gap than are achieved under inflation targeting. Terms of use: Documents inJEL Classification: E42, E52, E58.
Inflation targeting has been widely adopted in both developed and emerging economies. In this essay, I survey the evidence on the effects of inflation targeting on macroeconomic performance and assess what lessons this evidence provides for inflation targeting and the design of monetary policy. While macroeconomic experiences among both inflation targeting and non-targeting developed economies have been similar, inflation targeting has improved macroeconomic performance among developing economies. Importantly, inflation targeting has not been associated with greater real economic instability among either developed or developing economics. While cost shocks, such as the large rise in commodity prices that occurred in 2007 and early 2008, force central banks to make difficult short-run trade-offs, the ability to deal with demand shocks and financial crises can be enhanced by a commitment to an explicit target.
The canonical new Keynesian Phillips Curve has become a standard component of models designed for monetary policy analysis. However, in the basic new Keynesian model, there is no unemployment, all variation in labor input occurs along the intensive hours margin, and the driving variable for inflation depends on workers' marginal rates of substitution between leisure and consumption. In this paper, we incorporate a theory of unemployment into the new Keynesian theory of inflation and empirically test its implications for inflation dynamics. We show how a traditional Phillips curve linking inflation and unemployment can be derived and how the elasticity of inflation with respect to unemployment depends on structural characteristics of the labor market such as the matching technology that pairs vacancies with unemployed workers. We estimate on US data the Phillips curve generated by the model, and derive the implied marginal cost measure driving inflation dynamics. JEL: E52, E58, J64 1 Introduction The canonical new Keynesian Phillips curve has become a standard component of models designed for monetary policy analysis. Based on the presence of monopolistic competition among individual firms, together with the imposition of stagged price setting, the new Keynesian Phillips curve provides a direct link between the underlying structural parameters characterizing the preferences of individual suppliers of labor and the parameters appearing in the Phillips curve.
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