A Promised Value Approach to Optimal Monetary Policy

This paper characterizes optimal commitment policy in the New Keynesian model using a recursive formulation of the central bank's infinite-horizon optimization problem in which promised inflation and output gap - as opposed to lagged Lagrange multipliers - act as pseudo-state variables. Our recursive formulation is motivated by (Kydland, F. and Prescott, E. C. (1980).Journal of Economic Dynamics and ControlVol. 2, pp. 79-91). Using three well-known variants of the model - one featuring inflation bias, one featuring stabilization bias and one featuring a lower bound constraint on nominal interest rates - we show that the proposed formulation sheds new light on the nature of the intertemporal trade-off facing the central bank.