Discussion Paper Series 2005-E-7

What is the Proper Perspective for Monetary Policy Optimality?

Bennett T. McCallum

In forward-looking models for monetary policy analysis, the conditions for full conditional optimality are not time invariant, and as a consequence imply an incentive each period for the central bank to depart from its previous optimized plan. The conditional "commitment" plan is therefore strategically incoherent. Discretionary optimality does not have this problem, but yields inferior performance. A "timeless perspective" policy rule proposed by Woodford is intended to overcome the incoherence and non-credibility of the commitment plan while yielding performance superior to that of discretionary policy behavior; this rule has received much attention. A fourth "fully timeless" alternative differs slightly from the timeless-perspective rule; it is unambiguously superior from an unconditional perspective but does not dominate from the conditional perspective. The paper discusses comparisons at some length and briefly considers the sustainability of these policy strategies.

Keywords: policy rules; dynamic inconsistency; timeless perspective

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2005 Bank of Japan All Rights Reserved.

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