Optimal Choice of Monetary Policy Instruments

Optimal Choice of Monetary Policy Instruments Economics Assessed Coursework Consider the Poole (1970) model (W. Poole, Optimal choice of monetary policy instruments in a simple stochastic macro model, Quarterly Journal of Economics 84, 197-216):

Optimal Choice of Monetary Policy Instruments
Optimal Choice of Monetary Policy Instruments

yt = y0 ait+ut (1) mt = m0+byt cit+vt (2)

where ut and vt are independent random variables (i.e., Cov(u; v) = 0) with zero mean, and y0 and m0 are constant terms in the IS and LM curve respectively. Assume that the central bank wants to minimize the loss function

Lt =E(yt)2: (3)

  1. The minimum loss obtainable under an interest rate targeting regime (30


  1. The minimum loss obtainable under a monetary targeting regime (30 marks);
  2. Using your results in 1 and 2 above, discuss how the choice of the optimal policy instrument depends on the nature of the shock (40 marks).

Particular attention must be given to the theoretical explanation and economic intuition of all your equations and results. Please provide the full derivation of your results, with explanations of all steps taken to arrive at each solution. Results without evidence of their derivation, even if correct, will receive no credit.

Optimal Choice of Monetary Policy Instruments Notes

  1. The word limit is 2000 words (not characters – that is approx 2000 words not including equations or diagrams).
  2. Your work must be submitted via Turnitin. At this level, students are expected to type their whole assignment. If however, for some reason, this proves very di¢ cult you might want to scan any diagrams used. In either case, there should be one piece of an assignment submitted per student. If your assignment is in various pages, or pdf ÷les, please make sure that it is all submitted in one combined pdf ÷le (i.e. you could select all ÷les, right click and press “Combine ÷les in Acrobat” to join them all in one pdf ÷le).

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