Monetary Policy in a Forward-Looking Input–Output Economy


  • This is a revised version of the first chapter of my doctoral dissertation. It previously circulated under the title: “Discretionary Monetary Policy Design in a Sticky-Price Input/Output Economy.” I am grateful for the guidance and support from my main advisor, Lars Svensson, whose help has been of incalculable value. I also would like to thank Ricardo Reis, whose encouragement and comments have been especially helpful. This paper has also benefited from comments by Alan Blinder, Noah Williams, and two anonymous referees. I would also like to thank all of the participants of the Princeton Student International/Macro Workshop. The views expressed in this paper are my own and do not necessarily represent those of the Board of Governors or the staff of the Federal Reserve System. All remaining errors are, of course, my own.


This paper examines the implications for monetary policy of sticky prices in both final and intermediate goods in a New Keynesian model. Both optimal policy under commitment and discretionary policy under simple loss functions are studied. Household utility losses under alternative loss functions are compared; additionally, the robustness of policy performance to model and shock misperceptions and parameter uncertainty is examined. Targeting inflation in both consumer and intermediate goods performs better than targeting inflation in one sector; targeting price levels of both final and intermediate goods performs significantly better. Moreover, targeting price levels in both sectors yields superior robustness properties.