Abstract:
We consider optimal monetary policy in New Keynesian models with inertia. First order conditions, which we call the MJB-alternative, are found to improve upon the timeless perspective. The
MJB-alternative is shown to be the best possible in the sense that it
minimizes policymakers’ unconditional expected loss, and further, it
is numerically found to offer significant improvement over the timeless
perspective. Implementation of the MJB-alternative is considered via
construction of interest-rate rules that are consistent with its associated
unique equilibrium. Following Evans and Honkapohja (2004), an
expectations based rule is derived that always yields a determinate
model and an E-stable equilibrium. Further, the “policy manifold”
of all interest-rate rules consistent with the MJB-alternative is classified,
and open regions of this manifold are shown to correspond to indeterminate models and unstable equilibria.
