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Abstract:
Monetary policy reaction functions are compared in a simple optimizing model with one-period
nominal stickiness, i.i.d. shocks, and no capital accumulation. The interest rate is the instrument and is
either kept constant, "interest rate targeting" for short, or used in targeting one of the following: money,
the price level, output, nominal income (output), money growth, inflation, and the sum of inflation and
output. There are three varieties of one-period nominal stickiness---wage stickiness, wage and price
stickiness, and price stickiness---and three kinds of shocks---money demand shocks, goods demand shocks,
and productivity shocks. A given type of targeting is "better" than some other type for a given variable
and kind of shock if it results in smaller deviations of the variable from its target value. Some familiar
results regarding the ranking of types of targeting are confirmed in the optimizing model, and some new
results are obtained. It is not surprising that rankings may depend both on the type of shock and on which
variable is the target variable. However, it may be somewhat surprising that, given that wages are sticky,
rankings depend on whether prices are sticky, but that given that prices are sticky rankings do not
depend on whether wages are sticky.
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