This paper identifies optimal interest-rate rules within a rich, dynamic, general equilibrium model that has been shown to account well for observed aggregate dynamics in the postwar United States.We perform policy evaluations based on second-order accurate approximations to conditional and unconditional expected welfare.We require that interest-rate rules be operational, in the sense that they include as arguments only a few readily observable macroeconomic indicators and respect the zero bound on nominal interest rates.We find that the optimal operational monetary policy is a realinterest-rate targeting rule.That is, an interest-rate feedback rule featuring a unit inflation coefficient, a mute response to output, and no interest-rate smoothing.Contrary to existing studies, we find a significant degree of optimal inflation volatility.A key factor driving this result is the assumption of indexation to past inflation.Under indexation to long-run inflation the optimal inflation volatility is close to zero.Finally, we show that initial conditions matter for welfare rankings of policies.
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