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International Finance Discussion Papers
The International Finance Discussion Papers logo links to the International Finance Discussion Papers home page Optimal Monetary Policy with Durable and Non-Durable Goods
Christopher J. Erceg; Andrew T. Levin
2002-748  (December 2002, latest version March 2005)

Abstract:  We document that the durable goods sector is much more interest-sensitive than the non-durables sector, and then investigate the implications of these these sectoral differences for monetary policy. We formulate a two-sector general equilibrium model that is calibrated both to match the sectoral responses to a monetary policy shock derived from our empirical VAR, and to imply an empirically-realistic degree of sectoral output volatility and comovement. While the social welfare function involves sector-specific output gaps and inflation rates, the performance of the optimal policy rule can be closely approximated by a simple rule that targets a weighted average of aggregate wage and price inflation. In contrast, a rule that stabilizes a more narrow measure of final goods price inflation performs poorly in terms of social welfare.

Full paper, latest version (291 KB PDF)
Original version (418 KB PDF)

VAR analysis, DGE models, sectoral disaggregation

Related Material
Technical Appendix (186 KB PDF)   This appendix shows how we derive a second order approximation to the social welfare function of our model.

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