Three essays in monetary policy

Abstract

This dissertation consists of three essays about the implications of monetary policy in response to aggregate disturbances and the role of wage indexation under the objective of minimizing output deviation from the full equilibrium level of output. The first essay, entitled "Targeting Nominal Income: Further Results," analyzes the implications of monetary policy rules for the performance of the economy in the context of a simple stochastic macroeconomic model under rational expectations. The goal of this essay is to determine if nominal income targeting continues to provide the optimal response to both demand and supply disturbances in a model employing the Lucas supply curve. Unlike previous results, in a more general model, nominal GNP targeting does not respond optimally to both demand and supply shocks while a fixed money supply rule may be perfectly stabilizing when wages are indexed to unanticipated changes in the price. The second essay, titled "Monetary Policy Games and the Role of Wage Indexation," analyzes the role of wage indexation for the Fed's monetary policy in the context of a policy game. The objective of this essay is to examine the role of wage indexation as a resolution of the credibility problem. Full indexation eliminates not only the Fed's incentive to cheat but also the wage setters' losses when the Fed cheats. In the presence of both demand and supply shocks, indexation is not as powerful as it is in the absence of supply shocks. It does not offset the incentive to cheat, but improves the noncooperative solution. The third essay entitled "Is Increased Wage Flexibility Stabilizing?" is an analysis of the relationship between wage flexibility and output fluctuation in a continuous time model with demand and supply shocks. The major issues in this essay are: If there is a mixed distribution of shocks, how does each shock affect output fluctuation? What is the implication of contract length on the relationship between aggregate shocks and output variability? How are the results changed if workers can choose the optimal indexation parameter? This study tries to answer the questions raised above in a framework in which wage flexibility and output variability are endogenously determined.