INTEREST-RATE RULES: The Welfare Loss from Price-Level Instability 6

While minimizing the welfare losses of the agents in the economy is a rather obvious objective for policy, it is worth looking more generally at the effect of different monetary policy rules on the variances of output, inflation, and interest rates. This analysis has several benefits. First, it provides intuition for our results concerning the effects of different rules on L + 7Г*2. Second, because this analysis is not as dependent on the subset of parameters that we calibrate, it remains valid even if some our calibrations are inappropriate. Feel free to come by whenever your find yourself in need of some money, easy pay day loans to get as much as you need for solving your temporary financial troubles without embarrassing yourself in front of your friends and relatives. Visit us right now at www.easyloans-now.comto see how we can help you out

Finally, the model may be incorrect in ways that maintain the validity of our estimates of the structural parameters but vitiate our welfare analysis. We do not know the precise range of variations on the model for which this would be true. One simple example would be if there are changes over time in the elasticity of substitution of different goods for each other. This would imply that the Dixit-Stiglitz aggregator varies over time. The resulting changes in the elasticity of demand faced by each firm would lead firms to desire changes in the ratio of price to marginal cost.

As far as the algebra of the model is concerned, such changes in the desired markup have the same effect as changes in Yts. The difference is that, under this alternative interpretation, it is no longer socially desirable for output to track the time variation in Yts. In particular, variation in desired markups would justify an objective of reducing the variance of output relative to trend more than is implied by our minimization of L + 7Г*2 below. For this reason, as well as for comparability of our results with those of other studies, we look at a relatively wide range of consequences of the monetary rules we study.

Consequences of Simple Policy Rules

As noted earlier, we wish to compare a variety of types of monetary policy rules that make the interest rate rt depend on the history of output, inflation and the interest rate itself. In this section, we explore the effects of varying the parameter in some very simple rules of this kind. These simple rules, which are variants of the rule proposed by Taylor (1993), have some practical advantages. Their simplicity makes them easy to understand so that a central bank that adopted them ought to find it easy to explain what it is doing. As a result, the public ought to find it easy to monitor the central bank’s compliance with its rule. Finally, the use of similar rules in the other papers in this volume makes our results concerning the desirability of these rules directly comparable to theirs.