Optimal Monetary Policy: a New Keynesian View

As Paul Samuelson once put it: Adam Smith is dead and Keynes is dead; well— and Mises is dead, too. But Keynesianism is alive and well and back with a vengeance. Built on solid neoclassical foundations, this “new” Keynesianism, which features the effects of nominal rigidities in the presence of economic shocks and the existence of involuntary unemployment, represents the theoretical core of modern monetary policy. This article gives a short overview of the new Keynesian theory of optimal monetary policy. The concept of inflation targeting represents the core of this theory. It will be illustrated with the help of Walsh’s simple model of inflation targeting (Walsh 2001b). On the basis of this model, the implications of the theory of optimal monetary policy for practical monetary policy will be demonstrated.