Effective Monetary Policy Strategies in New Keynesian Models: A Re-examination

Abstract

We explore the importance of the nature of nominal price and wage adjustment for the design of effective monetary policy strategies, especially at the zero lower bound. Our analysis suggests that sticky-price and sticky-information models fit standard macroeconomic time series comparably well. However, the model with information rigidity responds differently to anticipated shocks and persistent zero-lower bound episodes -to a degree important for monetary policy and for understanding the effects of fundamental disturbances when monetary policy cannot adjust. These differences may be important for understanding other policy issues as well, such as fiscal multipliers. Despite these differences, many aspects of effective policy strategy are common across the two models: In particular, highly inertial interest rate rules that respond to nominal income or the price level perform well, even when hit by adverse supply shocks or large demand shocks that induce the zero-lower bound. Rules that respond to the level or change in the output gap can perform poorly under those conditions.

Optimal Monetary and Macroprudential Policies: Gains and Pitfalls in a Model of Financial Intermediation

“…Each of these features is crucial to good monetary policy design in New-Keynesian models, as recently emphasized in Chung, Herbst, and Kiley (2014).…”

“…The rule is specified in change form as a coefficient of one on the lagged nominal interest rate is essentially the optimal simple rule in our model, as in much of the NewKeynesian literature (e.g. Chung, Herbst, and Kiley (2014); note that we abstract from the lower bound on nominal interest rates). The upper surface, at a value of zero, is the comparison point (given by welfare under the Ramsey monetary and leverage tax rules, the same benchmark in table 4).…”

Dynamic Prediction Pools: An Investigation of Financial Frictions and Forecasting Performance

“…In the SWπ model, both price and wage markup shocks are important determinants of inflation in the (see Smets and Wouters (2007) and King and Watson (2012)). Policies that respond very strongly to the level of the gap in economic activity fare very poorly in terms of controlling inflation when faced with markup shocks (see Chung et al (2014)…”

Optimal monetary and macroprudential policies: Gains and pitfalls in a model of financial intermediation

“…Finally, monetary policy shows substantial inertia, a sizable response to inflation, and a large response to output growth (as in Smets and Wouters (2007)). Each of these features is crucial to good monetary policy design in New-Keynesian models, as recently emphasized in Chung, Herbst, and Kiley (2014).…”

“…The rule is specified in change form as a coefficient of one on the lagged nominal interest rate is essentially the optimal simple rule in our model, as in much of the New-Keynesian literature (e.g. Chung, Herbst, and Kiley (2014); note that we abstract from the lower bound on nominal interest rates). The upper surface, at a value of zero, is the comparison point (given by welfare under the Ramsey monetary and leverage tax rules, the same benchmark in table 4).…”