What is the optimal monetary policy for this model? Carefully explain why the monetary authority needs a ‘helping hand’ from fiscal policy to implement this policy.

Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible

The financial market opens at the beginning of the time “t” and time acquired as t – 1 is required for the nominal financial asset. The households hold the amount of nominal wealth as  and select to allocate the previously existing nominal assets. The money is  and the nominal state contingent bonds and unit of currency is considered in a particular state. One period that deposits the denominated currency  and pay back as  at the end of the period. The goods market opens at the second period of time. the balance of household money increase with the nominal amount of the revenues and then decreased with the value of expenses. The taxes that are paid and transferred are considered in the goods market opens. The money balances of household increase by nominal amount of the revenues and decrease value of expenses. The taxes are supposed to be paid and transferred (Fiore & Tristani, 2009). The required amount of the nominal balances is brought into the period “t+1” as

  The monetary policy can be characterized by optimal Ramsey plan. In addition the central bank is required to provide rule of  and . It is convenient to express the rules is terms of . Now considering the standard new Keynesian setup it gives

Considering it, the policy of constant  the money demand becomes recursive and cannot be neglected for the solution of the system.

a.      Assuming that the utility function of the household takes the following form

Work out the effect of the helping hand of fiscal policy on the supply of labor. Explain why this helps to offset the effects of monopolistic competition.

Considering the household, the type of worker is “j” with the utility

In the equation period of utility function U  is separable in labor and consumption. The utility of consumption C, u (C), and concave function with the inverse elasticity of the substitution  and the disutility of labor N, v (N) is the convex with the inverse Frisch elasticity . The utility from consumption and the disutility from the labor is scaled under the parameter  (Dennery, 2018). 

In the equation period of utility function U  is separable in labor and consumption. The utility of consumption C, u (C), and concave function with the inverse elasticity of the substitution  and the disutility of labor N, v (N) is the convex with the inverse Frisch elasticity . The utility from consumption and the disutility from the labor is scaled under the parameter  (Dennery, 2018).

The perfect competition is based on the good market and the production function diminish with the returns to labour  so the labor elasticity becomes

Problem 2

a.      Optimal targeting rules

Equation of economy

According to canonical closed economy new Keynesian model the augment is related to NK model with the consumption habits and working capital. The role of assumptions is based on the derivation of policy. The model consists of consumption Euler equation and Philip curve of inflation

In the monetary policy, the goal is to measure inflation targeting. The function allows to measure the inflation stabilization objective, gap stabilization and interest rate objective. The inflation rate is measured as  and the weights are assigned at the gap stabilization. Gap stabilization and inflation stabilization are denoted by  respectively. 

Problem 3

a.       New Keynesian model is used to derive the optimal value for inflation and output gap under the discretionary policy makers. The model also considers the nominal interest rate will respond to movements in natural rate of interest. According to the equation of steady state distortions and optimal Ramsey policy, the new Keynesian model is not bringing constant level of inflation.  The monetary policy can be described by the following simple rule

a.       New Keynesian model is used to derive the optimal value for inflation and output gap under the discretionary policy makers. The model also considers the nominal interest rate will respond to movements in natural rate of interest. According to the equation of steady state distortions and optimal Ramsey policy, the new Keynesian model is not bringing constant level of inflation.  The monetary policy can be described by the following simple rule

References of OPTIMAL

Dennery, C. (2018). Essays on macroeconomic implications of the Labour Market. Retrieved from etheses.lse.ac.uk: http://etheses.lse.ac.uk/3811/1/Dennery__essays-on-macroeconomic-implications.pdf

Devereux, M. B., Engel, C., & Lombardo, G. (2018). Implementable rules for international monetary policy coordination. International monetary , 01(01), 01-10. Retrieved from International monetary .

Fiore, F. D., & Tristani, O. (2009). optimal monetary policy in a model of the credit channel. Retrieved from www.ecb.europa.eu: https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1043.pdf