Optimal Target Criteria for Stabilization Policy

77 Pages Posted: 22 Jan 2012

See all articles by Marc P. Giannoni

Marc P. Giannoni

Barclays Corporate and Investment Bank; Center for Economic Policy Research (CEPR)

Michael Woodford

Columbia University, Graduate School of Arts and Sciences, Department of Economics

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Date Written: January 1, 2012

Abstract

This paper considers a general class of nonlinear rational-expectations models in which policymakers seek to maximize an objective function that may be household expected utility. We show how to derive a target criterion that is 1) consistent with the model’s structural equations, 2) strong enough to imply a unique equilibrium, and 3) optimal, in the sense that a commitment to adjust the policy instrument at all dates so as to satisfy the target criterion maximizes the objective function. The proposed optimal target criterion is a linear equation that must be satisfied by the projected paths of certain economically relevant “target variables.” It takes the same form at all times and generally involves only a small number of target variables, regardless of the size and complexity of the model. While the projected path of the economy requires information about its current state, the target criterion itself can be stated without reference to a complete description of the state of the world. We illustrate the application of the method to a nonlinear DSGE model with staggered price setting, in which the objective of policy is to maximize household expected utility.

Keywords: Optimal policy, Target criterion, Dynamic model, Optimal control

JEL Classification: C61, C62, E32, E52

Suggested Citation

Giannoni, Marc P. and Woodford, Michael, Optimal Target Criteria for Stabilization Policy (January 1, 2012). FRB of New York Staff Report No. 535, Available at SSRN: https://ssrn.com/abstract=1984209 or http://dx.doi.org/10.2139/ssrn.1984209

Marc P. Giannoni (Contact Author)

Barclays Corporate and Investment Bank ( email )

745 7th Avenue
New York, NY 10019
United States

Center for Economic Policy Research (CEPR)

90-98 Goswell Road
London, EC1V 7RR
United Kingdom

Michael Woodford

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

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