Should Monetary Policy stabilise real economic activity?

Riksbank has started a research series called Economic Commentaries which provides a snapshot of debates/economic topics/research.

I just read this first piece which is a snapshot of this longer article in this report – RAMSES – a new general equilibrium model for monetary policy analysis. The main idea is:

The new Keynesian theory is currently the dominant paradigm in monetary policy research on flexible inflation targeting. an important result from this research is that monetary policy should eliminate the effects of nominal rigidities. This implies a trade-off between stabilising inflation around a target and achieving an efficient resource utilisation.

The short piece discusses what this resource utilisation is, how can it be measured and how monetary policy can be used to minimise the gap.

One might get confused though. The famous Taylor rule also looks at both stabilising inflation and output. This new approach talks about efficient utilisation against stabilising utilisation (which Taylor rule advocates)

Flexible inflation targeting means that the central bank, in addition to stabilising inflation, tries to bring about the output level that would prevail in the absence of price rigidities. this output is known as flexprice output. the difference between actual and flexprice output is the flexprice gap. it is important to note that this measure of resource utilisation differs from traditional measures. traditional measures tell whether resource utilisation is high or low in relation to the normal level while the flexprice gap tells how resource utilisation relates to the efficient level.

However, it will be dificult to implement this approach:

it should, however, be emphasised that using the flexprice gap in practice is not a free lunch. it requires advanced analytical tools and models to calculate the flexprice gap, which can make it difficult for outsiders to replicate the results. in addition, the flexprice gap can differ from model to model, depending on the frictions and shocks included. Finally, it is a relatively complicated concept, which can make monetary policy communication more difficult.


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