Policy Maker’s Credibility with Predetermined Instruments for Forward-Looking Targets

Abstract

The aim of the present paper is to provide criteria for a central bank of how to choose among di¤erent monetary-policy rules when caring about a number of policy targets such as the output gap and expected in ‡ation. Special attention is given to the question if policy instruments are predetermined or only forward looking. Using the new-Keynesian Phillips curve with a cost-push-shock policy-transmission mechanism, the forward-looking case implies an extreme lack of robustness and of credibility of stabilization policy. The backward-looking case is such that the simple-rule parameters can be the solution of Ramsey optimal policy under limited commitment. As a consequence, we suggest to model explicitly the rational behavior of the policy maker with Ramsey optimal policy, rather than to use simple rules with an ambiguous assumption leading to policy advice that is neither robust nor credible.

How macroeconomists lost control of stabilization policy: towards dark ages

“…In a second approach, Currie and Levine (1985) defined a "simple rule" dynamic path including a proportional feedback rule when the policy target is a jump variable without an initial condition. Although the policy maker does not optimize, this equilibrium solu-tion can be a reduced form of Oudiz and Sachs' (1985) "discretion" model (Chatelain and Ralf (2020b)). Their "simple rule" solution also implies positive feedback rule parameters and exploding paths of the policy target.…”