The Implementation of Stabilization Policy

This paper addresses the issue of what path for the economy a policymaker can implement as the unique local equilibrium, given her observation set. I consider a broad class of locally linearizable dynamic stochastic discrete-time infinite-horizon rational-expectations models, which includes most existing DSGE models. I consider various alternative observation sets for the policymaker, depending on what she observes of the private sector's actions, its expectations, and exogenous shocks, and allowing for observation lags of any length. For each observation set and any local path that is consistent with the structural equations and this observation set, I provide conditions for the existence of a policy- instrument rule that is consistent with this observation set and implements that path as the unique local equilibrium. I also show how to design this rule arithmetically, and thus obtain its coefficients as rational functions of the parameters of the model and path considered. I apply these results to, and derive some of their implications for, the implementation of optimal monetary policy, monetary policy based on constant-interest-rate forecasts, debt-stabilizing tax policy, and optimal tax policy