Optimal interest-rate rules and inflation stabilization versus price-level stabilization

This paper compares the properties of interest-rate rules such as simple Taylor rules and rules that respond to price-level fluctuations (called Wicksellian rules) in a basic forward-looking model. By introducing appropriate history dependence in policy, Wicksellian rules perform better than optimal Taylor rules in terms of welfare, robustness to alternative shock processes, and are less prone to equilibrium indeterminacy. A simple Wicksellian rule augmented with a high degree of interest rate inertia resembles a robustly optimal rule, i.e., a monetary policy rule that implements the optimal plan and that is also completely robust to the specification of exogenous shock processes. (C) 2014 Elsevier B.V. All rights reserved.