The Elusive Welfare Economics of Price Stability as a Monetary Policy Objective: Should New Keynesian Central Bankers Pursue Price Stability?

Willem H. Buiter

NBER Working Paper No. 10848
Issued in October 2004
NBER Program(s):   IFM   ME

The paper studies the inflation rate associated with optimal monetary policy in a standard suite of DSGE models, when fiscal policy is either unrestricted optimal or restricted but supportive of monetary policy. Full nominal price flexibility, nominal prices set one period in advance and Calvo-style staggered overlapping price contracts with a variety of indexation rules for constrained price setters are considered.

For all price setting models, optimal monetary policy implements the Bailey-Friedman Optimal Quantity of Money (OQM) rule: the pecuniary opportunity cost of holding money is equal to zero.

There is an optimal inflation rate for producer prices in the Calvo model, given by the 'core inflation' process generated by the indexation rule of the constrained price setters. It is constant only if core inflation is constant.

A zero rate of producer price inflation is necessary for optimality in the Calvo model, only if all of the following conditions hold.

(1) There is no money or the nominal interest rate on money can be set freely.

(2) The constrained price setters of the Calvo model implement an ill-posed, arbitrary price indexation rule, such as the lagged partial indexation rule used by Woodford to make a case for price stability.

(3) The authorities use neither their tax instruments nor the nominal interest rate to validate the core inflation process.

These results are global - they do not depend on linear approximations at a deterministic, zero-inflation steady state.

download in pdf format
   (391 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w10848

Users who downloaded this paper also downloaded these:
Buiter w12919 Seigniorage
Buiter w10163 Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap
Buiter w12839 Is Numerairology the Future of Monetary Economics? Unbundling numeraire and medium of exchange through a virtual currency and a shadow exchange rate
Buiter and Miller w1252 Costs and Benefits of an Anti-Inflationary Policy: Questions and Issues
Fair w3990 The Cowles Commission Approach, Real Business Cycle Theories, and New Keynesian Economics
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us