Interest and Prices : Foundations of a Theory of Monetary Policy

by Woodford, Michael

• ISBN13: 9781400830169
• ISBN10: 1400830168
• Copyright: 2009-04-01
• Publisher: Princeton Univ Pr

Summary

With the collapse of the Bretton Woods system, any pretense of a connection of the world's currencies to any real commodity has been abandoned. Yet since the 1980s, most central banks have abandoned money-growth targets as practical guidelines for monetary policy as well. How then can pure "fiat" currencies be managed so as to create confidence in the stability of national units of account?Interest and Prices seeks to provide theoretical foundations for a rule-based approach to monetary policy suitable for a world of instant communications and ever more efficient financial markets. In such a world, effective monetary policy requires that central banks construct a conscious and articulate account of what they are doing. Michael Woodford reexamines the foundations of monetary economics, and shows how interest-rate policy can be used to achieve an inflation target in the absence of either commodity backing or control of a monetary aggregate.The book further shows how the tools of modern macroeconomic theory can be used to design an optimal inflation-targeting regime--one that balances stabilization goals with the pursuit of price stability in a way that is grounded in an explicit welfare analysis, and that takes account of the "New Classical" critique of traditional policy evaluation exercises. It thus argues that rule-based policymaking need not mean adherence to a rigid framework unrelated to stabilization objectives for the sake of credibility, while at the same time showing the advantages of rule-based over purely discretionary policymaking.

Table of Contents

Preface	p. xiii
The Return of Monetary Rules	p. 1
The Importance of Price Stability	p. 4
Toward a New "Neoclassical Synthesis"	p. 6
Microeconomic Foundations and Policy Analysis	p. 10
The Importance of Policy Commitment	p. 14
Central Banking as Management of Expectations	p. 15
Pitfalls of Conventional Optimal Control	p. 18
Monetary Policy without Control of a Monetary Aggregate	p. 24
Implementing Interest-Rate Policy	p. 25
Monetary Policy in a Cashless Economy	p. 31
Interest-Rate Rules	p. 37
Contemporary Proposals	p. 39
General Criticisms of Interest-Rate Rules	p. 44
Neo-Wicksellian Monetary Theory	p. 49
Plan of the Book	p. 55
Analytical Framework
Price-Level Determination under Interest-Rate Rules	p. 61
Price-Level Determination in a Cashless Economy	p. 62
An Asset-Pricing Model with Nominal Assets	p. 64
A Wicksellian Policy Regime	p. 74
Alternative Interest-Rate Rules	p. 85
Exogenous Interest-Rate Targets	p. 86
The Taylor Principle and Determinacy	p. 90
Inertial Responses to Inflation Variation	p. 94
Price-Level Determination with Monetary Frictions	p. 101
A Model with Transactions Frictions	p. 102
Interest-Rate Rules Reconsidered	p. 105
A Comparison with Money-Growth Targeting	p. 106
Consequences of Nonseparable Utility	p. 111
Self-Fulfilling Inflations and Deflations	p. 123
Global Multiplicity Despite Local Determinacy	p. 123
Policies to Prevent a Deflationary Trap	p. 131
Policies to Prevent an Inflationary Panic	p. 135
Optimizing Models with Nominal Rigidities	p. 139
A Basic Sticky-Price Model143
Pricesetting and Endogenous Output	p. 143
Consequences of Prices Fixed in Advance	p. 155
A New Classical Phillips Curve	p. 158
Sources of Strategic Complementarity	p. 163
Inflation Dynamics with Staggered Pricesetting	p. 173
The Calvo Model of Pricesetting	p. 177
A New Keynesian Phillips Curve	p. 187
Persistent Real Effects of Nominal Disturbances	p. 188
Consequences of Persistence in the Growth of Nominal Spending	p. 197
Consequences of Sectoral Asymmetries	p. 200
Delayed Effects of Nominal Disturbances on Inflation	p. 204
Staggered Pricing with Delayed Price Changes	p. 207
Consequences of Indexation to Past Inflation	p. 213
Consequences of Nominal Wage Stickiness	p. 218
A Model of Staggered Wagesetting	p. 221
Sticky Wages and the Real Effects of Nominal Disturbances	p. 226
A Neo-Wicksellian Framework for the Analysis of Monetary Policy	p. 237
A Basic Modelof the Effects of Monetary Policy	p. 238
Nonlinear Equilibrium Conditions	p. 239
A Log-Linear Approximate Model	p. 243
Interest-Rate Rules and Price Stability	p. 247
The Natural Rate of Interest	p. 247
Conditions for Determinacy of Equilibrium	p. 252
Stability under Learning Dynamics	p. 261
Determinants of Inflation	p. 276
Inflation Stabilization through Commitment to a Taylor Rule	p. 286
Inflation Targeting Rules	p. 290
Money and Aggregate Demand	p. 295
An Optimizing IS-LM Model	p. 295
Real-Balance Effects	p. 299
Fiscal Requirements for Price Stability	p. 311
Dynamics of the Response to Monetary Policy	p. 320
Delayed Effects of Monetary Policy	p. 321
Consequences of Predetermined Expenditure	p. 322
Habit Persistence in Private Expenditure	p. 332
Some Small Quantitative Models	p. 336
The Rotemberg-Woodford Model	p. 336
More Complex Variants	p. 345
Monetary Policy and Investment Dynamics	p. 352
Investment Demand with Sticky Prices	p. 353
Optimal Pricesetting with Endogenous Capital	p. 357
Comparison with the Basic Neo-Wicksellian Model	p. 361
Capital and the Natural Rate of Interest	p. 372
Optimal Policy
Inflation Stabilization and Welfare	p. 381
Approximation of Loss Functions and Optimal Policies	p. 383
A Utility-Based Welfare Criterion	p. 392
Output-Gap Stability and Welfare	p. 393
Inflation and Relative-Price Distortions	p. 396
The Case for Price Stability	p. 405
The Case of an Efficient Natural Rate of Output	p. 407
Consequences of a Mildly In Efficient Natural Rate of Output	p. 411
Caveats	p. 416
Extensions of the Basic Analysis	p. 419
Transactions Frictions	p. 420
The Zero Interest-Rate Lower Bound	p. 427
Asymmetric Disturbances	p. 435
Sticky Wages and Prices	p. 443
Time-Varying Tax Wedges or Markups	p. 448
The Case of Larger Distortions	p. 455
Gains from Commitment to a Policy Rule	p. 464
The Optimal Long-Run Inflation Target	p. 468
The Inflationary Bias of Discretionary Policy	p. 469
Extensions of the Basic Analysis	p. 476
Optimal Responses to Disturbances	p. 484
Cost-Push Shocks	p. 486
Fluctuations in the Natural Rate of Interest	p. 501
Optimal Simple Policy Rules	p. 507
The Optimal Noninertial Plan	p. 510
The Optimal Taylor Rule	p. 513
The Optimal State-Contingent Instrument Path as a Policy Rule	p. 517
Commitment to an Optimal Targeting Rule	p. 521
Robustly Optimal Target Criteria	p. 522
Implementation of a Target Rule	p. 527
Optimal Monetary Policy Rules	p. 534
A General Linear-Quadratic Framework	p. 535
Optimal State-Contingent Paths	p. 536
Alternative Forms of Policy Rules	p. 543
Robustness to Alternative Types of Disturbances	p. 547
Existence of Robustly Optimal Policy Rules	p. 550
Optimal Instrument Rules	p. 555
Optimal Inflation Targeting Rules	p. 559
A Model with Inflation Inertia	p. 560
A Model with Wages and Prices Both Sticky	p. 565
A Model with Habit Persistence	p. 568
Predetermined Spending and Pricing Decisions	p. 569
Optimal Policy for a Small Quantitative Model	p. 573
Optimal Interest-Rate Rules	p. 582
An Optimal Rule for the Basic Neo-Wicksellian Model	p. 583
Consequences of Inflation Inertia	p. 592
Predetermined Spending and Pricing Decisions	p. 604
Optimal Policy under Imperfect Information	p. 606
Reflections on Currently Popular Policy Proposals	p. 610
The Taylor Rule	p. 610
Inflation-Forecast Targeting	p. 619
Appendixes
Addendum to Chapter 2	p. 627
Addendum to Chapter 3	p. 656
Addendum to Chapter 4	p. 656
Addendum to Chapter 5	p. 687
Addendum to Chapter 6	p. 692
Addendum to Chapter 7	p. 709
Addendum to Chapter 8	p. 716
References	p. 747
Index	p. 765
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