Consistent Targets and Optimal Monetary Policy: A Note

Kydland and Prescott (1977) develop a simple model of monetary policy making, where the central bank needs some commitment technique to achieve optimal monetary policy over time. Although not their main focus, they illustrate the difference between consistent and optimal policy in a sequential-decision one-period world. We employ the analytical method developed in Yuan and Miller (2005), whereby the government appoints a central bank with consistent targets or delegates consistent targets to the central bank. Thus, the central bank s welfare function differs from the social welfare function, which cause consistent policy to prove optimal.

Policy Advice during a Crisis

Good policy making is an art. It involves a substantial element of personal judgement about risks and consequences of alternative courses of actions and decisions. It is also a science because it requires systematic gathering and analysis of evidence about a policy issue, and rational assessment of costs and benefits of various ways of addressing the issue. However, in a crisis, there is little time to gather evidence or to search for imaginative solutions to a problem. There is a tendency, in such a situation, to act under pressure rather than on the basis of evidence, analysis or informed judgement. Furthermore, a crisis often creates a situation in which policy makers receive all sorts of advice. This note discusses a set of concepts, originating mainly from economics, that can be used to assess soundness of policy and advice, particularly during a crisis. These are concepts of rationality, sustainability, inclusiveness, feasibility, practicality and tipping, which can be used in decision making in normal and crisis times to reduce risks of disastrous advice or policy.

Representing Afghanistan: The United States and Democracy's Imposition

There is an ongoing mission in Afghanistan; a mission driven by external political forces. At its core this mission hopes to establish peace, to protect the populace, and to install democracy. Each of these goals has remained just that, a goal, for the past eight years as the American and international mission in Afghanistan has enjoyed varied levels of commitment. Currently, the stagnant progress in Afghanistan has led the international community to become increasingly concerned about the viability of a future Afghan state. Most of these questions take root in the question over whether or not an Afghan state can function without the auspices of international terrorism. Inevitably, the normative question of what exactly that government should be arises from this base concern. In formulating a response to this question, the consensus of western society has been to install representative democracy. This answer has been a recurring theme in the post Cold War era as states such as Bosnia and Somalia bear witness to the ill effects of external democratic imposition. I hypothesize that the current mold of externally driven state-building is unlikely to result in what western actors seek it to establish: representative democracy. By primarily examining the current situation in Afghanistan, I claim that external installation of representative democracy is modally flawed in that its process mandates choice. Representative democracy by definition constitutes a government reflective of its people, or electorate. Thus, freedom of choice is necessary for a functional representative democracy. From this, one can deduce that because an essential function of democracy is choice, its implementation lies with the presence of choice. State-building is an imposition that eliminates that necessary ingredient. The two stand as polar opposites that cannot effectively collaborate. Security, governing capacity, and development have all been targeted as measurements of success in Afghanistan. The three factors are generally seen as mutually constitutive; so improved security is seen as improving governing capacity. Thus, the recent resurgence of the Taliban in Afghanistan and a deteriorating security environment moving forward has demonstrated the inability of the Afghan government to govern. The primary reason for the Afghan government’s deficiencies is its lack of legitimacy among its constituency. Even the use of the term ‘constituency’ must be qualified because the Afghan government has often oscillated between serving the people within its territorial borders and the international community. The existence of the Afghan state is so dependent on foreign aid and intervention that it has lost policy-making and enforcing power. This is evident by the inability of Afghanistan to engage in basic sovereign state activities as maintaining a national budget, conducting elections, providing for its own national security, and deterring criminality. The Afghan state is nothing more than a shell of a government, and indicative of the failings that external state-building has with establishing democracy.

A General Schema for Optimal Monetary Policymaking: Objectives and Rules

This paper examines four equivalent methods of optimal monetary policymaking, committing to the social loss function, using discretion with the central bank long-run and short-run loss functions, and following monetary policy rules. All lead to optimal economic performance. The same performance emerges from these different policymaking methods because the central bank actually follows the same (similar) policy rules. These objectives (the social loss function, the central bank long-run and short-run loss functions) and monetary policy rules imply a complete regime for optimal policy making. The central bank long-run and short-run loss functions that produce the optimal policy with discretion differ from the social loss function. Moreover, the optimal policy rule emerges from the optimization of these different central bank loss functions.

The Making of Optimal and Consistent Policy: An Analytical Framework for Monetary Models

This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the central bank should adopt a loss function that differs from the social loss function. Carefully designing the central bank s loss function with consistent targets can harmonize optimal and consistent policy. This desirable result emerges from two observations. First, the social loss function reflects a normative process that does not necessarily prove consistent with the structure of the microeconomy. Thus, the social loss function cannot serve as a direct loss function for the central bank. Second, an optimal loss function for the central bank must depend on the structure of that microeconomy. In addition, this paper shows that control theory provides a benchmark for institution design in a game-theoretical framework.

The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy

This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the social loss function cannot serve as a direct loss function for the central bank. Accordingly, we employ implementation theory to design a central bank loss function (mechanism design) with consistent targets, while the social loss function serves as a social welfare criterion. That is, with the correct mechanism design for the central bank loss function, optimal policy and consistent policy become identical. In other words, optimal policy proves implementable (consistent).