Dear Johannes,
I have seen papers about monetary policy rule responds to financial slack represented by stock price gap in addition to inflation and output gap, please refer to the PDF attachment. I have three questions:
Does monetary policy rule necessarily respond to future inflation and future output gap in addition to output gap and inflation?
Does financial slack in monetary policy rule represent expectation about future inflation and future output gap?
In some Asian countries like China, people said that monetary policy rule responds to credit to gdp gap in addition to output gap and inflation, does credit to GDP gap also represent expectation about future inflation and future output gap?
DSGE1.pdf (726.6 KB)
Thank you very much and look forward to hearing from you.
Best regards,
Jesse
first of all the design of simple monetary policy rules reflects the set of objectives that you assume for the central bank (e.g. inflation around 2%, output close to natural output, low financial stress, etc.).
In general, the answer is “no”. There is no need to introduce forecast targeting.
But from the welfare point of view of optimal simple rules the answer would be “it depends on your underlying model/assumptions”.
There is a correspondence between the optimal degree of forward-looking behavior of monetary policy and the structure of (forward/backward-looking) private agents’ expectations.
In the end, we don’t really know what actual policy-makers are doing, we are only trying to capture their behavior.
Fully optimal monetary policy under commitment is fully state contingent, i.e. can react to all states. The optimal simple rules you have in mind restricts the policy to responding to the particular variables you specify. A priori, it’s unclear how bad the resulting approximation is. It’s similar with future expected variables. In equilibrium, the future expected variables also map back to the states.