Inflation/Output Variance Trade-Offs and Optimal Monetary Policy.

The author estimates the inflation/output-gap variance trade-off faced by monetary policymakers in the United States. For policymakers who care about deviations of inflation around target and output around potential, the estimated trade-off represents the 'optimal policy frontier.' Given the structure of the economy, policymakers can do no better than to attain weighted variances of inflation and output that lie on the frontier. The author finds that the variance trade-off becomes quite severe when the standard deviation of inflation or output drops much below 2 percent. This suggests that approximately balanced responses to policy goals are consistent with reasonable preferences over inflation and output variability. Copyright 1997 by Ohio State University Press.