Second-Order Approximation to the Rotemberg Model around a Distorted Steady State

Less is known about social welfare objectives when it is costly to change prices, as in Rotemberg (1982), compared with Calvo-type models. We derive a quadratic approximate welfare function around a distorted steady state for the costly price adjustment model. We highlight the similarities and differences to the Calvo setup. Both models imply inflation and output stabilization goals. It is explained why the degree of distortion in the economy influences inflation aversion in the Rotemberg framework in a way that differs from the Calvo setup.

On Measuring the Efficiency of Monetary Policy

Cecchetti et al. (2006) develop a method for allocating macroeconomic performance changes among the structure of the economy, variability of supply shocks and monetary policy. We propose a dual approach of their method by borrowing well-known tools from production theory, namely the Farrell measure and the Malmquist index. Following FÄare et al (1994) we propose a decomposition of the efficiency of monetary policy. It is shown that the global efficiency changes can be rewritten as the product of the changes in macroeconomic performance, minimum quadratic loss, and efficiency frontier.

Ordering Policy Rules with an Unconditional Welfare Measure

The unconditional expectation of social welfare is often used to assess alternative macroeconomic policy rules in applied quantitative research. It is shown that it is generally possible to derive a linear - quadratic problem that approximates the exact non-linear problem where the unconditional expectation of the objective is maximised and the steady-state is distorted. Thus, the measure of pol icy performance is a linear combinat ion of second moments of economic variables which is relatively easy to compute numerically, and can be used to rank alternative policy rules. The approach is applied to a simple Calvo-type model under various monetary policy rules.