Premium
Optimal Monetary Policy Inertia
Author(s) -
Woodford Michael
Publication year - 1999
Publication title -
the manchester school
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.361
H-Index - 42
eISSN - 1467-9957
pISSN - 1463-6786
DOI - 10.1111/1467-9957.67.s1.1
Subject(s) - economics , inertia , monetary policy , interest rate , inflation (cosmology) , context (archaeology) , simple (philosophy) , inertial frame of reference , output gap , function (biology) , central bank , microeconomics , monetary economics , econometrics , macroeconomics , paleontology , philosophy , physics , epistemology , classical mechanics , quantum mechanics , evolutionary biology , theoretical physics , biology
I consider the desirability of the observed tendency of central banks to adjust interest rates only gradually in response to changes in economic conditions. I show, in the context of a simple model of optimizing private sector behaviour, that such inertial behaviour on the part of the central bank may indeed be optimal, in the sense of minimizing a loss function that penalizes inflation variations, deviations of output from potential and interest rate variability. Sluggish adjustment characterizes an optimal policy commitment, even though no such inertia would be present in the case of discretionary optimization.