HT - 04. Optimal Monetary Policy

Question 1

Woodford (1999)

Answer 1

Timeless perspective, abstract from time inconsistency problem of commitment policy.

Question 2

Clarida, Galí and Gertler (1999)

Answer 2

Aim: summarise lessons from NKM model on MP
• Gains from enhancing credibility via formal commitment?

Conclusion:
• Optimal policy without commitment embeds inflation targeting, calling for gradual adjustment to the optimal inflation rate  CB should adjust nominal rate by more than 1:1 with expected future inflation.
• CB should offset demand shocks, accommodate supply shocks.
• Commitment can eliminate inflation bias: without commitment inefficiently, high inflation may arise in steady state if real output target too high
• Optimal policies implied by most frameworks generate interest rate paths far more volatile than seen in practice.