Optimal Monetary Policy and Expectation Driven Business Cycles

Guo, Shen (2007): Optimal Monetary Policy and Expectation Driven Business Cycles. Unpublished.

Abstract

We explore the optimal response of central bank when a news shock hits the economy, that is, agents’ optimistic expectation of an improvement in technology does not realize. Ramsey optimal policy and simple policy rules are studied in a two-sector model with price rigidities in each of non-durable and durable sector. We find that a simple policy rule reacting to the inflation rates in both non-durable and durable sector with appropriate weights can mimic the performance of the Ramsey policy closely. Another interesting result is that monetary policy plays an important role in generating expectation driven business cycles.

• Item Type: MPRA Paper
• Institution: Concordia University
• Language: English
• Keywords: News shocks; Expectation driven business cycles; Optimal monetary policy
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy (Targets, Instruments, and Effects); E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations; Cycles