In this seminar Zulfiqar Hyder will provide an overview of his recent paper, Optimal Monetary Policy with Capital Formation and Financial Frictions. In this paper, Zulfiqar extends the traditional optimal monetary policy analysis to the New Keynesian model with capital & financial frictions. By doing so, the paper compares the performance of Ramsey monetary policy with alternative monetary policy regimes such as standard inflation targeting and Taylor rule.

In case of a negative productivity shock, the main results of this paper are: First, inflation targeting rule emerges as the best policy compared to the Ramsey policy and Taylor rule in the NK model without capital; Second, Ramsey policy and inflation targeting perform better compared to Taylor rule in combating inflation in the standard new Keynesian model with capital which is in line with Goodfriend & King (2001) and Woodford (2003); and Third, the NK model with capital & with financial frictions, which comprises of balance sheet effects, Ramsey policy outperforms alternative monetary policies because a real interest rate undercut more than alternative monetary policies. The relative performance of the model’s economy under inflation targeting regime is worst even compared to Taylor rule, which shows that maintaining price stability is not optimal in response to a productivity shock in the presence of financial frictions into a standard NK model as in Carlstrom et al. (2010). Zulfiqar concludes that the main result in a financial Shock is that Ramsey policy performs well, compared to alternative monetary policy regime, by minimizing the impact of financial constraints on interest rate spread aggressively. However, Zero Lower Bound becomes bindings with a large financial shock.

Zulfiqar Hyder is a PhD candidate at the Centre for Applied Macroeconomic Analysis. His research interests are macroeconomics and monetary policy with a focus on financial frictions and optimal monetary policy. He also holds a Master degree in Development Economics from Center for Development Economics (CDE), Williams College.

The CAMA Macroeconomics Brown Bag Seminars offer CAMA speakers, in particular PhD students, an opportunity to present their work in progress in front of their peers, and reputable visitors to showcase their work.