The Science of Monetary Policy: A New Keynesian Perspective

TLDR

The paper reviews recent literature on monetary policy rules. It develops a simple baseline theoretical framework for monetary policy design and examines how real‑world complications and frictions such as imperfect information alter the optimal policy. The study finds that optimal policy naturally incorporates inflation targeting and that credible commitment to fight inflation yields gains, even when the central bank does not aim to push output above its natural level.

Abstract

The paper reviews the recent literature on monetary policy rules. We exposit the monetary policy design problem within a simple baseline theoretical framework. We then consider the implications of adding various real world complications. Among other things, we show that the optimal policy implicitly incorporates inflation targeting. We also characterize the gains from making a credible commitment to fight inflation. In contrast to conventional wisdom, we show that gains from commitment may emerge even if the central bank is not trying to inadvisedly push output above its natural level. We also consider the implications of frictions such as imperfect information.