Research Discussion Papers, Bank of Finland
No 8/2007:
Discretion and the transmission lags of monetary policy
Juha Kilponen ()
and Kai Leitemo ()
Abstract: Monetary policy transmission lags create credibility
problems for the inflation-targeting policy maker who acts under
discretion. We show that if prices react to monetary policy with a longer
lag than output, the welfare maximizing inflationtargeting policy implies
no policy stabilization of cost-push shocks in the canonical New Keynesian
model. The reason is simple: for the period monetary policy influences
output, inflation is predetermined and the best discretionary policy is to
stabilize the output gap fully. We find that money growth targeting comes
close to replicating the welfare-maximizing policy under commitment if
there are transmission lags.
Keywords: discretionary and stabilization bias; monetary policy; transmission lags; inflation targeting; money targeting; (follow links to similar papers)
JEL-Codes: E52; E58; E61; (follow links to similar papers)
27 pages, August 15, 2007
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