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This paper uses a structurally estimated macroeconometric model, denoted the MC model, to evaluate inflation targeting in the United States. Various interest rate rules are tried with differing weights on inflation and output, and various optimal control problems are solved using differing weights on inflation and output targets. Price-level targeting is also considered. The results show that 1) there are output costs to inflation targeting, especially for price shocks, 2) price-level targeting is dominated by inflation targeting, 3) the estimated interest rate rule of the Fed (in Table 4) is consistent with the Fed placing equal weights on inflation and unemployment in a loss function, 4) the estimated interest rate rule does a fairly good job at lowering variability, and 5) considerable economic variability is left after the Fed has done its best. Overall, the results suggest that the Fed should continue to behave as it has in the past.

Economic outcomes in dynamic economies with forward-looking agents depend crucially on whether or not the central bank can precommit, even in the absence of the traditional “inflation bias.” This paper quantifies the welfare differential between precommitment and discretionary policy in both a stylized theoretical framework and in estimated data-consistent models. From the precommitment and discretionary solutions we calculate the permanent deviation of inflation from target that in welfare terms is equivalent to moving from discretion to precommitment, the “inflation equivalent.” In the estimated models, using a range of reasonable central bank preference parameters, the “inflation equivalent” ranges from 0.05 to 3.6 percentage points, with a mid-point of either 0.15 or 1–1.5 percentage points, depending on the model. In addition to the degree of forward-looking behavior, we show that the existence of transmission lags and/or information lags is crucial for determining the welfare gain from precommitment.

In this paper we develop a sticky price DSGE model to study the role of capital market imperfections for monetary policy implementation. Recent empirical and theoretical studies have stressed the effect of firms’ external finance on their pricing decisions. The so-called cost channel of the transmission mechanism has been explored within New Keynesian frameworks that pose particular emphasis on inflation dynamics. These models generally disregard the role of external …nance for the dynamics of asset prices. We ask whether monetary policy should respond to deviations of asset prices from their frictionless level and, more importantly, if the answer to this question changes when financial frictions are properly taken into account. We analyze these issues from the vantage of equilibrium determinacy and stability under adaptive learning. We show that usual conditions for equilibrium uniqueness and E-stability are significantly altered when the cost channel matters. Nevertheless, we find that responding to actual or expected asset price misalignments helps at restoring determinacy and stability under learning. These conclusions are further enforced in the presence of a high degree of pass-through from policy to bank lending rates.

The views expressed are those of the individual authors and do not necessarily reflect official positions of the Federal Reserve Bank of St. Louis, the Federal Reserve System, or the Board of Governors. Federal Reserve Bank of St. Louis Working Papers are preliminary materials circulated to stimulate discussion and critical comment. References in publications to Federal Reserve Bank of St. Louis Working Papers (other than an acknowledgment that the writer has had access to unpublished material) should be cleared with the author or authors.

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In this paper, I consider the lessons recent academic research and historical experiences with monetary targeting and inflation targeting offer for the design of monetary policy regimes. The practical experiences with both monetary and inflation targeting suggest that successful policies have incorporated a great deal of flexibility. In principle, both monetary targeting and inflation targeting can ensure the economy has a nominal anchor and be implemented in a transparent manner that promotes accountability. However, a policy that focuses on a goal, such as inflation, is less sensitive to structural change and instability in the economy than is an intermediate targeting procedure such as monetary targeting. However, inflation targeting should not be interpreted as a commitment to an instrument rule such as a Taylor rule. Such rules suffer from the same sensitivity to structural change that intermediate targeting rules do. And, to date, inflation targeting central banks have been transparent with respect to only one of their policy objectives.

In this paper we calculate robustly optimal monetary policy rules for several variants of a simple optimizing model of the monetary transmission mechanism with sticky prices and/or wages. We discuss representations of optimal policy both in terms of interest-rate feedback rules that generalize the well-known "Taylor rule," and in terms of commitment to a target criterion of the kind discussed in familiar proposals for "flexible inflation targeting." Optimal rules, however, require that policy be history-dependent in ways not contemplated by many well-known proposals. We furthermore find that a robustly optimal policy rule is almost inevitably an implicit rule, that requires the central bank to use a structural model to project the economy's evolution under the contemplated policy action. Finally, our numerical examples suggest that optimal rules do not place nearly as much weight on projections of inflation or output many quarters in the future as occurs under the current practice of inflation-forecast targeting central banks.

It is an honour to provide a few comments on Carl Walsh’s excellent paper, which revisits some fundamental monetary policy issues. Walsh’s paper highlights many useful lessons that can be learned from the conventional framework and its various extensions. However, the financial crisis provides a stark and costly reminder of just how incomplete the standard model is. I will concentrate on the future of monetary policy in light of both the lessons of the crisis and the prospect of some central banks having more formal responsibility to promote financial stability. I will take as my starting point Walsh’s observation that: “distortions in financial markets that generate real effects of monetary policy also imply that financial stability may require making trade-offs with the goals of inflation stability and stability of real economic activity. ” 1 There is an emerging consensus that price stability does not guarantee financial stability and is, in fact, often associated with excess credit growth and emerging asset bubbles. 2 There is also general agreement that the first line of defence should be better regulation, including new macroprudential tools. However, it is less widely recognized that this will mean it is not “business as usual ” for monetary policy. At a minimum, the regulatory