Supply-side effects of monetary policy and the central bank’s objective function

Abstract

This paper considers a new Keynesian model with the cost channel and evaluates the supply-side e§ects of monetary policy on macroeco nomic volatility and welfare, taking into account the endogenous na ture of the objective function of monetary authorities. When the cost channel matters, supply-side e§ects of monetary policy depend on the degree of interest rate pass-through and the degree of price rigidity. Numerical results show that the welfare consequences of an increase in the degree of interest rate pass-through are independent of how the central bank speciÖes its loss function. By contrast, the welfare conse quences of an increase in price rigidity depend critically on the nature of the loss function considered. Macroeconomic volatility as a func tion of the pass-through is almost independent of the central bankís loss function. In contrast, this volatility as a function of the degree of price rigidity depends more on the nature of the loss function.