Author Description

This Paper Analyzes The Use Of Unconventional Policy Instruments In New Keynesian Setups In Which The ‘divine Coincidence’ Breaks Down. The Paper Discusses The Role Of A Second Instrument And Its Coordination With Conventional Interest Rate Policy, And Presents Theoretical Results On Equilibrium Determinacy, The Inflation Bias, The Stabilization Bias, And The Optimal Central Banker’s Preferences When Both Instruments Are Available. We Show That The Use Of An Unconventional Instrument Can Help Reduce The Zone Of Equilibrium Indeterminacy And The Volatility Of The Economy. However, In Some Circumstances, Committing Not To Use The Second Instrument May Be Welfare Improving (a Result Akin To Rogoff (1985a) Example Of Counterproductive Coordination). We Further Show That The Optimal Central Banker Should Be Both Aggressive Against Inflation, And Interventionist In Using The Unconventional Policy Instrument. As Long As Price Setting Depends On Expectations About The Future, There Are Gains From Establishing Credibility By Using Any Instrument That Affects These Expectations. Cover -- Contents -- I. Introduction -- Ii. Analytical Framework -- A. The Extended New Keynesian Framework -- B. The Rationale For Unconventional Policy Instruments -- C. An Example -- Iii. The Need For Unconventional Policy Instruments -- A. Equilibrium Determinacy -- B. Optimal Stabilization Policy Following Real Shocks -- Iv. Central Banker's Preferences -- A. The Stabilization Bias -- B. The Stabilization Bias When Optimal Preferences Trigger Multiple Equilibria -- C. The Inflationary Bias -- V. Conclusion -- References -- Figures -- 1. Optimal Policy Determinacy Condition -- 2. Optimal Preferences Determinacy -- 3. Welfare Loss Variations In The Determinacy Area -- Appendix -- A. Proof Of Proposition 3 -- B. Proof Of Proposition 4. Zineddine Alla, Raphael Espinoza, Atish Ghosh.