{
  "title": "Unconventional Policy Instruments in the New Keynesian Model",
  "publication": "IMF Working Papers, March 10, 2016",
  "sourceUrl": "https://www.imf.org/en/publications/wp/issues/2016/12/31/unconventional-policy-instruments-in-the-new-keynesian-model-43782",
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  "summary": "This paper analyzes the use of unconventional policy instruments in New Keynesian setups in which the ‘divine coincidence’ breaks down.",
  "sections": [
    {
      "heading": "Overview",
      "content": "- Paper analyzes the use of unconventional policy instruments in New Keynesian setups in which the ‘divine coincidence’ breaks down.\n- Discusses the role of a second instrument and its coordination with conventional interest rate policy.\n- Presents theoretical results on equilibrium determinacy, the inflation bias, the stabilization bias, and the optimal central banker’s preferences when both instruments are available."
    },
    {
      "heading": "Theoretical results",
      "content": "- Introducing a second (unconventional) instrument can:\n  - Reduce the zone of equilibrium indeterminacy.\n  - Reduce the volatility of the economy.\n- In some circumstances, committing not to use the second instrument may be welfare improving (analogous to Rogoff (1985a) example of counterproductive coordination).\n- When price setting depends on expectations about the future, any instrument that affects these expectations can yield credibility gains."
    },
    {
      "heading": "Findings on policy interactions and biases",
      "content": "- Equilibrium determinacy:\n  - Use of an unconventional instrument can shrink the region of indeterminate equilibria.\n- Inflation bias and stabilization bias:\n  - The presence of a second instrument affects both the inflation bias and the stabilization bias; the paper provides theoretical characterizations of these effects.\n- Volatility:\n  - Availability and appropriate use of the unconventional instrument can lower macroeconomic volatility."
    },
    {
      "heading": "Optimal central banker preferences and behavior",
      "content": "- The optimal central banker should:\n  - Be aggressive against inflation.\n  - Be interventionist in using the unconventional policy instrument.\n- Credibility considerations:\n  - Establishing credibility by using instruments that shape expectations has welfare gains as long as price setting depends on expectations about the future.\n- Coordination trade-offs:\n  - There exist cases where refraining from using the unconventional instrument (commitment not to use it) improves welfare, indicating potential counterproductive coordination problems."
    },
    {
      "heading": "Policy recommendations and implications",
      "content": "- Consider incorporating unconventional instruments alongside conventional interest rate policy to improve determinacy and reduce volatility.\n- Evaluate the potential welfare trade-offs of committing to not use unconventional instruments in specific circumstances.\n- Design central bank preferences and operational frameworks to be both inflation-focused and willing to actively deploy unconventional tools when they affect expectations and outcomes."
    },
    {
      "heading": "Subjects and keywords",
      "content": "- Subjects: Banking, Financial frictions, Inflation, Neoclassical theory, Output gap\n- Keywords: WP\n\nSource: Unconventional Policy Instruments in the New Keynesian Model, Zineddine Alla, Raphael A Espinoza, and Atish R. Ghosh, March 10, 2016.\n\n---\n\n Content in this bundle\n\n- wp1658 — Section 2: Analytical framework and main results\n  - wp1658 — Section 2: Analytical framework and main results (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - wp1658 — Section 2: Analytical framework and main results (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2016/12/31/unconventional-policy-instruments-in-the-new-keynesian-model-43782"
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    "Authors: Zineddine Alla, Raphael A Espinoza, Atish R. Ghosh",
    "Published: March 10, 2016",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9781513573038.001",
    "Paper analyzes the use of unconventional policy instruments in New Keynesian setups in which the ‘divine coincidence’ breaks down.",
    "Discusses the role of a second instrument and its coordination with conventional interest rate policy.",
    "Presents theoretical results on equilibrium determinacy, the inflation bias, the stabilization bias, and the optimal central banker’s preferences when both instruments are available.",
    "Introducing a second (unconventional) instrument can:",
    "In some circumstances, committing not to use the second instrument may be welfare improving (analogous to Rogoff (1985a) example of counterproductive coordination).",
    "When price setting depends on expectations about the future, any instrument that affects these expectations can yield credibility gains.",
    "Equilibrium determinacy:",
    "Inflation bias and stabilization bias:",
    "Volatility:",
    "The optimal central banker should:",
    "Credibility considerations:",
    "Coordination trade-offs:",
    "Consider incorporating unconventional instruments alongside conventional interest rate policy to improve determinacy and reduce volatility.",
    "Evaluate the potential welfare trade-offs of committing to not use unconventional instruments in specific circumstances.",
    "Design central bank preferences and operational frameworks to be both inflation-focused and willing to actively deploy unconventional tools when they affect expectations and outcomes.",
    "Subjects: Banking, Financial frictions, Inflation, Neoclassical theory, Output gap",
    "Keywords: WP",
    "**_wp1658 — Section 2: Analytical framework and main results**"
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