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In this paper I study the effect of imperfect central bank commitment on inflationary outcomes. I present a model in which the monetary authority is a committee that consists of members who serve overlapping, finite terms. Older and younger generations of Monetary Policy Committee (MPC) members decide on policy by engaging in a bargaining process. I show that this setup gives rise to a continuous measure of the degree of monetary authority's commitment. The model suggests that the lower the churning rate or the longer the tenure time, the closer social welfare will be to that under optimal commitment policy.
This paper studies an overlapping generations economy with capital where limited communication and stochastic relocation create an endogenous transactions role for fiat money. We assume a production function with a knowledge externality (Romer-style) that nests economies with endogenous growth (AK form) and those with no long-run growth (the Diamond model). We show that the Tobin effect is always operative. Under CRRA (constant relative risk aversion) preferences, a mild degree of social increasing returns is sufficient (but not necessary) for some positive inflation to dominate zero inflation and for the Friedman rule to be suboptimal, irrespective of the degree of risk aversion.
The form of bounded rationality characterizing the representative agent is key in the choice of the optimal monetary policy regime. While inflation targeting prevails for myopia that distorts agents' inflation expectations, price level targeting emerges as the optimal policy under myopia regarding the output gap, revenue, or interest rate. To the extent that bygones are not bygones under price level targeting, rational inflation expectations is a minimal condition for optimality in a behavioral world. Instrument rules implementation of this optimal policy is shown to be infeasible, questioning the ability of simple rules à la Taylor (1993) to assist the conduct of monetary policy. Bounded rationality is not necessarily associated with welfare losses.
The Fed has taken several steps towards strengthening its monetary framework over the past several years. Those steps have supported the Fed’s efforts to stimulate the economy through forward guidance despite being constrained by having policy rates at zero. We show that an optimal control approach to monetary policy, which includes the publication of a baseline forecast and a description of the uncertainties around that outlook, combined with an improvement in the Fed’s communications toolkit, could further enhance the effectiveness of Fed policy. In the current conjuncture, such a risk management approach to monetary policy would result in both a later liftoff of policy rates and a modest, but planned, overshooting of inflation.
Macroeconomic policy is one of the most important policy domains, and the tools of macroeconomics are among the most valuable for policy makers. Yet there has been, up to now, a wide gulf between the level at which macroeconomics is taught at the undergraduate level and the level at which it is practiced. At the same time, doctoral-level textbooks are usually not targeted at a policy audience, making advanced macroeconomics less accessible to current and aspiring practitioners. This book, born out of the Masters course the authors taught for many years at the Harvard Kennedy School, fills this gap. It introduces the tools of dynamic optimization in the context of economic growth, and then applies them to a wide range of policy questions – ranging from pensions, consumption, investment and finance, to the most recent developments in fiscal and monetary policy. It does so with the requisite rigor, but also with a light touch, and an unyielding focus on their application to policy-making, as befits the authors’ own practical experience. Advanced Macroeconomics: An Easy Guide is bound to become a great resource for graduate and advanced undergraduate students, and practitioners alike.
We construct a computational dynamic stochastic overlapping generations general equilibrium model with uncertain lifetimes and explore the impact of policy stickiness (specifically, a major reform will preclude future reforms for a generation) on optimal long-run fiscal policy. Under such circumstances, entitlement reforms exhaust a valuable option to move in the future. We explore the conditions under which the gain to waiting is large enough to induce optimizing policymakers to delay reforming a suboptimal system. We also allow for the uncertainty to have ARCH characteristics and explore the impact of time-varying uncertainty on the optimality of delayed policy action.
Economic growth, low inflation, and financial stability are among the most important goals of policy makers, and central banks such as the Federal Reserve are key institutions for achieving these goals. In Asset Prices and Monetary Policy, leading scholars and practitioners probe the interaction of central banks, asset markets, and the general economy to forge a new understanding of the challenges facing policy makers as they manage an increasingly complex economic system. The contributors examine how central bankers determine their policy prescriptions with reference to the fluctuating housing market, the balance of debt and credit, changing beliefs of investors, the level of commodity prices, and other factors. At a time when the public has never been more involved in stocks, retirement funds, and real estate investment, this insightful book will be useful to all those concerned with the current state of the economy.