Optimal interest rate stabilization in a basic sticky-price model

This paper studies optimal monetary policy with the nominal interest rate as the single policy instrument. Firms set prices in a staggered way without indexation and real money balances contribute separately to households' utility. The optimal deterministic steady state under commitment is the Friedman rule-even if the importance assigned to the utility of money is small relative to consumption and leisure. We approximate the model around the optimal steady state as the long-run policy target. Optimal monetary policy is characterized by stabilization of the nominal interest rate instead of inflation stabilization as the predominant principle. (C) 2008 Elsevier B.V. All rights reserved.