Phillips Curve Instability and Optimal Monetary Policy

By Troy Davig

First version: July 2007
This version: June 2008

 
RWP 07-04
Research Division
Federal Reserve Bank of Kansas City


Abstract    

This paper assesses the implications for optimal discretionary monetary policy if the slope of the Phillips curve changes. The paper first derives a Phillips curve from the optimal pricing decision of a monopolistic firm that faces a changing cost of price adjustment. The second aspect of the paper constructs a utility-based welfare criterion. A novel feature of this criterion is that is has a relative weight on output gap deviations that changes synchronously with changes in the cost of price adjustment. The systematic component of the targeting rule that implements the optimal discretionary policy under the utility-based criteria is constant. In contrast, the systematic component of the targeting rule under an ad-hoc criteria changes along with changes in the slope of the Phillips curve.


Keywords: Optimal monetary policy, Phillips curve, regime-switching


JEL classification: E52, E58, E61


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