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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
A Promised Value Approach to Optimal Monetary Policy
Timothy S. Hills
Taisuke Nakata
Takeki Sunakawa
Abstract

This paper characterizes optimal commitment policy in the New Keynesian model using a novel recursive formulation of the central bank's infinite horizon optimization problem. In our recursive formulation motivated by Kydland and Prescott (1980), promised inflation and output gap---as opposed to lagged Lagrange multipliers---act as pseudo-state variables. Using three well known variants of the model---one featuring inflation bias, one featuring stabilization bias, and one featuring a lower bound constraint on nominal interest rates---we show that the proposed formulation sheds new light on the nature of the intertemporal trade-off facing the central bank.


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Timothy S. Hills & Taisuke Nakata & Takeki Sunakawa, A Promised Value Approach to Optimal Monetary Policy, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2018-083, 03 Dec 2018.
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Keywords: Commitment ; Inflation bias ; Optimal policy ; Ramsey plans ; Stabilization bias ; Zero lower bound
DOI: 10.17016/FEDS.2018.083
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