On the Optimality of Nominal GDP Targeting Under Distortionary Taxation
In this thesis the welfare properties of three different monetary policy rules are considered, (i) inflation targeting, (ii) nominal GDP targeting, and (iii) a standard Taylor rule. This is done in the hope of determining whether or not the frequently discussed nominal GDP targeting rule for monetary policy possesses any welfare improving properties over the other two policy rules considered. To perform this analysis a New Keynesian dynamic stochastic general equilibrium model featuring imperfect competition, nominal rigidities, investment, and distortionary taxation is derived and then solved using perturbation methods, with various parameters of the model being estimated for Icelandic data using Bayesian estimation techniques. The main findings of the thesis are that nominal GDP targeting seems to possess significant welfare improving properties over the other two monetary policy rules considered, managing to minimise the welfare loss resulting from the nominal rigidities as well as the significant welfare loss resulting from the presence of distortionary taxes. This however does not necessarily imply that nominal GPD targeting is an optimal monetary policy rule, owing to the fact that there are significant practical problems associated with the adoption of such a rule.