## Unconventional Policy Instruments in the New Keynesian Model

_IMF Working Papers, March 10, 2016_

## Source details

**Canonical URL:** [Unconventional Policy Instruments in the New Keynesian Model](https://www.imf.org/en/publications/wp/issues/2016/12/31/unconventional-policy-instruments-in-the-new-keynesian-model-43782)

## Other formats

- [Markdown version](/en/publications/wp/issues/2016/12/31/unconventional-policy-instruments-in-the-new-keynesian-model-43782/index.md)
- [Structured JSON version](/en/publications/wp/issues/2016/12/31/unconventional-policy-instruments-in-the-new-keynesian-model-43782/index.json)
- [Bundle manifest](/en/publications/wp/issues/2016/12/31/unconventional-policy-instruments-in-the-new-keynesian-model-43782/bundle-manifest.json)

## Bibliographic details
- 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

---

### Overview
- 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.

### Theoretical results
- Introducing a second (unconventional) instrument can:
  - Reduce the zone of equilibrium indeterminacy.
  - Reduce the volatility of the economy.
- 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.

### Findings on policy interactions and biases
- Equilibrium determinacy:
  - Use of an unconventional instrument can shrink the region of indeterminate equilibria.
- Inflation bias and stabilization bias:
  - The presence of a second instrument affects both the inflation bias and the stabilization bias; the paper provides theoretical characterizations of these effects.
- Volatility:
  - Availability and appropriate use of the unconventional instrument can lower macroeconomic volatility.

### Optimal central banker preferences and behavior
- The optimal central banker should:
  - Be aggressive against inflation.
  - Be interventionist in using the unconventional policy instrument.
- Credibility considerations:
  - Establishing credibility by using instruments that shape expectations has welfare gains as long as price setting depends on expectations about the future.
- Coordination trade-offs:
  - There exist cases where refraining from using the unconventional instrument (commitment not to use it) improves welfare, indicating potential counterproductive coordination problems.

### Policy recommendations and implications
- 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 and keywords
- Subjects: Banking, Financial frictions, Inflation, Neoclassical theory, Output gap
- Keywords: WP

*Source: Unconventional Policy Instruments in the New Keynesian Model, Zineddine Alla, Raphael A Espinoza, and Atish R. Ghosh, March 10, 2016.*

---

## Content in this bundle

- **_wp1658 — Section 2: Analytical framework and main results**
  - [_wp1658 — Section 2: Analytical framework and main results (Markdown version)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp1658.pdf.md){rel="alternate" type="text/markdown"}
  - [_wp1658 — Section 2: Analytical framework and main results (PDF)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp1658.pdf){rel="external" type="application/pdf"}

---

_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/unconventional-policy-instruments-in-the-new-keynesian-model-43782_