Hostname: page-component-89b8bd64d-nlwjb Total loading time: 0 Render date: 2026-05-09T08:16:44.881Z Has data issue: false hasContentIssue false
  • English
  • Français

OPTIMAL POLICY IN RATIONAL EXPECTATIONS MODELS: NEW SOLUTION ALGORITHMS

Published online by Cambridge University Press:  18 January 2007

RICHARD DENNIS
RICHARD DENNIS
Affiliation:
Federal Reserve Bank of San Francisco
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper develops methods to solve for optimal discretionary policies and optimal commitment policies in rational expectations models. These algorithms, which allow the optimization constraints to be conveniently expressed in second-order structural form, are more general than existing methods and are simple to apply. We use several New Keynesian business cycle models to illustrate their application. Simulations show that the procedures developed in this paper can quickly solve small-scale models and that they can be usefully and effectively applied to medium- and large-scale models.

Keywords

Optimal PolicyCommitmentDiscretion

Information

Type
ARTICLES
Information
Macroeconomic Dynamics , Volume 11 , Issue 1 , February 2007 , pp. 31 - 55
Copyright
© 2007 Cambridge University Press

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Article purchase

Temporarily unavailable

References

Amman H. and D. Kendrick 1999 Linear quadratic optimization for models with rational expectations. Macroeconomic Dynamics 3, 534– 543.Google Scholar
Anderson E. Hansen L. McGrattan E. and T. Sargent 1996 Mechanics of forming and estimating dynamic linear economies. In Amman H. Kendrick D. and J. Rust (eds.), Handbook of Computational Economics, Vol. 1, Ch. 4. New York: North Holland.
Anderson G. and G. Moore 1985 A linear algebraic procedure for solving linear perfect foresight models. Economics Letters 17, 247– 252.Google Scholar
Backus D. and J. Driffill 1986 The Consistency of Optimal Policy in Stochastic Rational Expectations Models. Centre for Economic Policy Research Discussion Paper 124.
Binder M. and H. Pesaran 1995 Multivariate rational expectations models and macroeconomic modeling: a review and some new results. In H. Pesaran and M. Wickens (eds.), Handbook of Applied Econometrics. Blackwell Publishers, Oxford.
Blake A. 2004 Open loop time consistency for linear rational expectations models. Economics Letters 82, 21– 27.Google Scholar
Calvo G. 1983 Staggered prices in a utility-maximizing framework. Journal of Monetary Economics 12, 383– 398.Google Scholar
Chen B. and P. Zadrozny 2002 An alternative feedback solution for the infinite-horizon, linear-quadratic, dynamic, Stackelberg game. Journal of Economic Dynamics and Control 26, 1397– 1416.Google Scholar
Christiano L. 2002 Solving dynamic equilibrium models by a method of undetermined coefficients. Computational Economics 20, 21– 55.Google Scholar
Clarida R. Galí J. and M. Gertler 1999 The science of monetary policy: A new Keynesian perspective. Journal of Economic Literature 37, 1661– 1707.Google Scholar
Currie D. and P. Levine 1985 Macroeconomic policy design in an interdependent world. In Buiter W. and R. Marston (eds.), International Economic Policy Coordination. Cambridge: Cambridge University Press.
Currie D. and P. Levine 1993 Rules, Reputation and Macroeconomic Policy Coordination Cambridge University Press Cambridge.
Dennis R. 2004a Solving for optimal simple rules in rational expectations models. Journal of Economic Dynamics and Control 28, 1635– 1660.Google Scholar
Dennis R. 2004b Inferring policy objectives from economic outcomes. Oxford Bulletin of Economics and Statistics 66, 735– 764.Google Scholar
Dennis R. and U. Söderström (Forthcoming) How important is precommitment for monetary policy. Journal of Money, Credit, and Banking.
Diaz-Gimenez J. 1999 Linear quadratic approximations: An introduction. in Marimon R. and A. Scott (eds.), Computational Methods for the Study of Dynamic Economies. Oxford: Oxford University Press.
Erceg C. Henderson D. and A. Levin 2000 Optimal monetary policy with staggered wage and price contracts. Journal of Monetary Economics 46, 281– 313.Google Scholar
Fuhrer J. 1997 Inflation/output variance trade-offs and optimal monetary policy. Journal of Money, Credit, and Banking 29, 214– 234.Google Scholar
Fuhrer J. and G. Moore 1995 Inflation persistence. Quarterly Journal of Economics 110, 127– 159.Google Scholar
Galí J. and T. Monacelli 2005 Monetary policy and exchange rate volatility in a small open economy. Review of Economic Studies 72, 707– 734.Google Scholar
Giannoni M. and M. Woodford 2002 Optimal Interest-Rate Rules: I. General Theory. Princeton University mimeo.
Holly S. and A. Hughes-Hallett 1989 Optimal Control, Expectations and Uncertainty. Cambridge: Cambridge University Press.
Jensen C. and B. McCallum 2002 The non-optimality of proposed monetary policy rules under timeless perspective commitment. Economics Letters 77, 163– 168.Google Scholar
King R. and M. Watson 2002 System reduction and solution algorithms for singular linear difference systems under rational expectations. Computational Economics 20, 57– 86.Google Scholar
Klein P. 2000 Using the generalized Schur form to solve a multivariate linear rational expectations model. Journal of Economic Dynamics and Control 24, 1405– 1423.Google Scholar
Krusell P. Quadrini V. and J-V. Rios-Rull 1997 Politico-economic equilibrium and economic growth. Journal of Economic Dynamics and Control 21, 243– 272.Google Scholar
Kydland F. and E. Prescott 1977 Rules rather than discretion: The inconsistency of optimal plans. Journal of Political Economy 87, 473– 492.Google Scholar
Kydland F. and E. Prescott 1980 Dynamic optimal taxation, rational expectations and optimal control. Journal of Economic Dynamics and Control 2, 79– 91.Google Scholar
McCallum B. 1999 Solutions to linear rational expectations models: A compact exposition. Economics Letters 61, 143– 147.Google Scholar
Orphanides A. and V. Wieland 1998 Price Stability and Monetary Policy Effectiveness When Nominal Interest Rates are Bounded at Zero. Board of Governors of the Federal Reserve, Finance and Economics Discussion Paper 1998-35.
Oudiz G. and J. Sachs 1985 International policy coordination in dynamic macroeconomic models. In Buiter W. and R. Marston (eds.), International Economic Policy Coordination, 275– 319. Cambridge: Cambridge University Press.
Rustem B. and M. Zarrop 1979 A Newton-type method for the optimization and control of non-linear econometric models. Journal of Economic Dynamics and Control 1, 283– 300.Google Scholar
Sims C. 2002 Solving linear rational expectations models. Computational Economics 20, 1– 20.Google Scholar
Söderlind P. 1999 Solution and estimation of RE macromodels with optimal policy. European Economic Review 43, 813– 823.Google Scholar
Svensson L. 2000 Open-economy inflation targeting. Journal of International Economics 50, 155– 183.Google Scholar
Svensson L. 2003 What is wrong with Taylor rules? Using judgement in monetary policy through targeting rules. Journal of Economic Literature June, 426– 477.Google Scholar
Taylor J. 1999 Monetary Policy Rules. Chicago: University of Chicago Press.
Uhlig H. 1999 A toolkit for analysing nonlinear dynamic stochastic models easily. In Marimon R. and A. Scott (eds.), Computational Methods for the Study of Dynamic Economies. New York: Oxford University Press.
Woodford M. 1999 Commentary: How should monetary policy be conducted in an era of price stability? Presented at the Symposium on New Challenges for Monetary Policy, organized by the Federal Reserve Bank of Kansas City at Jackson Hole, Wyoming, August 26–28.
Woodford M. 2002 Interest & Prices. Princeton, NJ: Princeton University Press.