European Financial and Accounting Journal 2013, 8(1):18-38 | DOI: 10.18267/j.efaj.94

Monetary Policy as an Optimal Control Problem

Jan Kodera1, Van Quang TRAN2
1 Prof. RNDr. Ing. Jan Kodera, CSc. - Professor; Department of Monetary Theory and Policy, Faculty of Finance and Accounting, University of Economics, Prague, Nam. W. Churchilla 4, 130 67 Praha 3; .
2 Ing. Tran Van Quang, PhD, Department of Statistics and Probability, University of Economics, Prague, Faculty of Statistics and Informatics, Nam. W. Churchilla 4, 130 67 Praha 3; .

This paper analyses the monetary policy of a central bank in a simple deterministic and continuous dynamic non-linear New-Keynesian model with an active central bank conducting monetary policy within inflation targeting framework. To meet this purpose, first we derive two differential equations capturing the dynamics in the economy: the dynamic IS curve representing the commodity market and the Phillips curve capturing the connection between the real and nominal sectors of the economy in a continuous form. By introducing a quadratic loss function commonly used in New Keynesian Economics we get optimal control problem which solution will be analysed with the use of fuzzy control. Then we introduce a modified form of the Taylor rule and analyse the solution of the same differential equations capturing the dynamics of the economy using Taylor rule instead of loss function. The comparison of the solutions of both models will be demonstrated in examples in which the main characteristic of dynamics of production and inflation are displayed.

Keywords: Deterministic continuous model, Dynamic IS curve, Loss function, Modified Taylor rule, New- Keynesian Phillips curve, Optimal control problem
JEL classification: C61, E58

Published: March 1, 2013  Show citation

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Kodera, J., & TRAN, V.Q. (2013). Monetary Policy as an Optimal Control Problem. European Financial and Accounting Journal, 8(1), 18-38. doi: 10.18267/j.efaj.94
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