Monetary Policy in a Forward-Looking Input-Output Economy

This paper examines the implications for monetary policy of sticky prices in both final and intermediate goods in a New Keynesian model. Both optimal policy under commitment and discretionary policy under simple loss functions are studied. Household utility losses under alternative loss functions are compared; additionally, the robustness of policy performance to model and shock misperceptions and parameter uncertainty is examined. Targeting inflation in both consumer and intermediate goods performs better than targeting inflation in one sector; targeting price levels of both final and intermediate goods performs significantly better. Moreover, targeting price levels in both sectors yields superior robustness properties.