DP7482 Delegating Optimal Monetary Policy Inertia

Author(s): Florin Ovidiu Bilbiie
Publication Date: October 2009
Keyword(s): inflation, output gap growth and nominal income growth targeting., discretion and commitment, inertia, optimal delegation, stabilization bias, time inconsistency, timeless-optimal policy
JEL(s): C61, C73, E31, E52, E61
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7482

This paper shows that absent a commitment technology, central banks can nevertheless achieve the (timeless-)optimal commitment equilibrium if they are delegated with an objective function that is different from the societal one. In a prototypical forward-looking New Keynesian model, I develop a general linear-quadratic method to solve for the optimal delegation parameters that generate the optimal amount of inertia in a Markov-perfect equilibrium. I study the optimal design of some policy regimes that are nested within this framework: inflation, output-gap growth and nominal income growth targeting; and inflation and output-gap contracts. Notably, since the timeless-optimal equilibrium is time-consistent, so is any delegation scheme that implements it.