Optimal Interest-Rate Rules: II. Applications

Abstract

In this paper we calculate robustly optimal monetary policy rules for several variants of a simple optimizing model of the monetary transmission mechanism with sticky prices and/or wages.We discuss representations of optimal policy both in terms of interest-rate feedback rules that generalize the well-known "Taylor rule," and in terms of commitment to a target criterion of the kind discussed in familiar proposals for "flexible inflation targeting."Optimal rules, however, require that policy be history-dependent in ways not contemplated by many well-known proposals.We furthermore find that a robustly optimal policy rule is almost inevitably an implicit rule, that requires the central bank to use a structural model to project the economy's evolution under the contemplated policy action.Finally, our numerical examples suggest that optimal rules do not place nearly as much weight on projections of inflation or output many quarters in the future as occurs under the current practice of inflation-forecast targeting central banks.

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