Optimal monetary policy, endogenous supply and rational expectations

In this paper we demonstrate that the choice of monetary policy regime will affect the variability of output when private agents, in forming their supply decisions, take into account the authority's selection of a policy rule. A striking feature of the analysis is that the choice between policy rules in Sargent-Wallace (1975) framework, but with endogenous aggregate supply, depends only on the variability of aggregate demand under each rule and not on the variability of aggregate supply. It follows that the choice of monetary policy rules reduces to the problem analyzed by Poole (1970) in the stochastic Keynesian structure.