Optimal Monetary Policy In A Hybrid New Keynesian Model With A Cost Channel

This paper shows that an expectations-based optimal policy rule has desirable properties in a standard macroeconomic model incorporating a cost channel for monetary disturbances and inflation rate expectations that are partly backward looking. Specifically, optimal monetary policy under commitment is associated with a determinate REE that is stable under learning, whereas, under discretion, the central bank has to be sufficiently inflation averse for the equilibrium to have these properties. To overcome the problem with the indeterminacy of REE that is a typical result when an optimal policy rule for the central bank is implemented in a standard macroeconomic model, Evans and Honkapohja (2003a - c, 2006) argue that the interest rate rule should be implemented as an expectations-based rule.