Scandinavian Working Papers in Economics

Working Paper Series,
Uppsala University, Department of Economics

No 2012:7: Optimal Monetary Policy under Learning in a New Keynesian Model with Cost Channel and Inflation Inertia

Mikael Bask () and Christian R Proaño
Additional contact information
Mikael Bask: Department of Economics, Postal: Uppsala University, P.O. Box 513, SE-751 20 Uppsala, Sweden
Christian R Proaño: Department of Economics, Postal: The New School for Social Research, New York, NY

Abstract: We show that a so-called expectations-based optimal monetary policy rule has desirable properties in a standard New Keynesian model augmented with a cost channel and inflation rate expectations that are partly backward-looking. In particular, optimal monetary policy under commitment is associated with a determinate rational expectations equilibrium that is stable under least squares learning for all parameter constellations considered, whereas, under discretion in policy-making, the central bank has to be sufficiently inflation rate averse for the rational expectations equilibrium to have the same properties.

Keywords: Commitment; Cost Channel; Determinacy; Discretion; Inflation Inertia; Least Squares Learning; Optimal Monetary Policy

JEL-codes: C62; E52

25 pages, February 29, 2012

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