Monetary Policy for Inattentive Economies

By Laurence Ball, Ricardo Reis. 2005

288 citations recorded by the source corpus.

This paper is a contribution to the analysis of optimal monetary policy. It begins with a critical assessment of the existing literature, arguing that most work is based on implausible models of inflation-output dynamics. It then suggests that this problem may be solved with some recent behavioral models, which assume that price setters are slow to incorporate macroeconomic information into the prices they set. A specific such model is developed and used to derive optimal policy. In response to shocks to productivity and aggregate demand, optimal policy is price level targeting. Base drift in the price level, which is implicit in the inflation targeting regimes currently used in many central banks, is not desirable in this model. When shocks to desired markups are added, optimal policy is flexible targeting of the price level. That is, the central bank should allow the price level to deviate from its target for a while in response to these supply shocks, but it should eventually return the price level to its target path. Optimal policy can also be described as an elastic price standard: the central bank allows the price level to deviate from its target when output is expected to deviate from its natural rate.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/6d9dd896b08efc20ee4bb20b919a8c042dd38b88

Citations in the corpus

• Optimal Monetary Policy with Imperfect Common Knowledge (2003, unknown): “The Centre for Economic Policy Research was established in 1983 as a private educational charity, to promote independent analysis and public discussion of open economies and the relations among them.”
• Information Rigidity and the Expectations Formation Process: A Simple Framework and New Facts (2012, unknown): “As a result, our framework can help determine 1 For example, Ball et al. (2005) show that price-level targeting is optimal in sticky-information models whereas inflation targeting is optimal in a sticky-price model.”
• Optimal Monetary Stabilization Policy (2010, unknown): “If J = ∞, as in the case assumed by Mankiw and Reis (2002) and Ball et al. (2005), we once again find that optimal policy requires that the outputgap-adjusted price level follow a deterministic path for all t ≥ t0.”
• Exogenous Information, Endogenous Information and Optimal Monetary Policy (2014, unknown): “At the optimal monetary policy, the price level does not respond to aggregate technology shocks.”
• Consumption Dynamics under Information Processing Constraints (2006, unknown): “As in Campbell (1987), we may also easily examine the predictions of the PIH model with RI for the behavior of saving.”
• Inflation targeting and optimal monetary policy (2004, unknown): “The fact that a similar conclusion is obtained in the case of “sticky information” is illustrated by the analysis of Ball et al. (2003).”