Book Description
This paper investigates theoretically and empirically which monetary policy rule is optimal for minimizing the expected social loss function among possible monetary policy rules in closed and open economies. This paper incorporates IS and LM relationships in the basic economic model such that aggregate demand shocks can be further decomposed into IS and LM shocks and the effects of the shocks can be analyzed. This paper finds no evidence that the nominal GDP rule is the optimal under all circumstances, but that the optimality of monetary policy rule depends significantly on the parameters of the model. In the open economy model, the major findings are as follows: First, a high sensitivity of real interest rate on real expenditure favors the nominal GDP rule. Second, a large and equivalent weight placed on inflation stability and exchange rate stability in the loss function favors the exchange rate rule, and a large weight placed on inflation stability relative to exchange rate stability favors the nominal GDP rule. Third, a large slope coefficient in a Lucas supply function tends to favor the nominal GDP rule.
