Optimal Policy and the Sectoral Composition of Output in a New Keynesian Model
Vahagn Galstyan, IIIS, Trinity College Dublin
Michael Wycherley, IIIS, Trinity College Dublin
Abstract
The standard New Keynesian model allows the derivation of optimal monetary
policy on the assumption that the economy is composed of a single sector. This paper
analyses optimal policy on the basis that the economy comprises a number of
different sectors. It shows that the composition of output matters, that policy should
take into account the source of shocks as well as well as their aggregate magnitude, and that policy tools impacting individual sectors can be welfare improving. If sectoral
policy is not adopted, then commitment in tax policy is important in similar
ways and for similar reasons to commitment in monetary policy. With sectoral policy,
commitment for tax and monetary policies ceases to be important.
JEL classification: E12; E32; E50; E63
Keywords: Tax policy; Monetary Policy; Multi-sector model; Welfare