Optimal Monetary Policy in a simple backward and forward looking Models

Abstract

The growing dynamics of macroeconomic and political environment across the globe particularly in developing countries where high inflation appears persistent, and trade -off between low stable inflation and full employment are becoming more challenging for monetary and fiscal authorities and has increase the needs to review the optimal monetary policy choice by the central banks. The present study investigates the optimal monetary policy choice in a backward and forward looking model. In particular, the study adopt an explorative review where both theoretical and empirical literature on the subject were reviewed and synthesized. The findings from literature revealed that there is no consensus on whether the optimal monetary policy should be backward looking or forward looking as both have their own unique advantages. The study concludes that a hybrid of both forward and backward-looking model where more weights is assigned to forward looking variables will improve the responsiveness of monetary policy decision on real macroeconomic variables like inflation, employment and economic growth.