The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy

Huiping Yuan () and Stephen Miller

No 2006-06, Working papers from University of Connecticut, Department of Economics

Abstract: This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the social loss function cannot serve as a direct loss function for the central bank. Accordingly, we employ implementation theory to design a central bank loss function (mechanism design) with consistent targets, while the social loss function serves as a social welfare criterion. That is, with the correct mechanism design for the central bank loss function, optimal policy and consistent policy become identical. In other words, optimal policy proves implementable (consistent).

JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2006-02, Revised 2009-01
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Note: We presented an earlier version at Federal Reserve Bank of Boston.
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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https://media.economics.uconn.edu/working/2006-06.pdf Full text (original version) (application/pdf)

Related works:
Working Paper: The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:uct:uconnp:2006-06

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