Survey_Billi_2004

Abstract

The model is calibrated to the U.S. economy accounting for the high degree of inflation persistence as actually observed in the data, e.g., Christiano, Eichenbaum and Evans (2001) and Giannoni and Woodford (2003). From a technical point of view, the policy problem as studied in this paper simultaneously addresses three specific features, each of which significantly aggravates its solution. These features are the occasionally binding constraint on the policy instrument, the standard conditions of uncertainty, and the forward-looking nature of the model. Only recently, nonlinear numerical methods apt to solving this general class of problems have been developed, see Adam and Billi (2003a) for the purely forward-looking case. A standard dynamic general equilibrium framework with nominal rigidities from staggered price-setting behavior of firms is considered. It is well-known in the literature as the ‘New Keynesian’ model, as described by Clarida, Galí and Gertler (1999) and Woodford (2003). Log-linearizing the model around the deterministic steady-state, apart from the zero lower bound on nominal interest rates, reduces it to a twoequation system: an aggregate-supply relation capturing the price-setting behavior of firms, and an intertemporal IS relation describing the private expenditure decisions of households.10 This otherwise standard monetary policy problem is here augmented by explicitly imposing the lower bound, kept in its original nonlinear form. The optimal monetary policy problem introduced in the previous section is calibrated to the U.S. economy. The baseline parametrization is summarized in table 1. The values assigned to the structural parameters of the economy are taken from table 6.1 in Woodford (2003). Interestingly, the weight ? derived from the underlying structure of the economy is equal to 0.003 quarterly. This is only a small fraction of unity that instead is commonly assumed in the literature on the evaluation of monetary policy rules, based on the idea that the central bank should give equal weight to its stabilization objectives. In addition, following Christiano, Eichenbaum and Evans (2001) and the estimates of Giannoni and Woodford (2003), the degree of inflation indexation ? is set close to unity, namely 0.99.