Abstract
This paper establishes an optimal monetary policy to combat inflation in an economy wherein the inflationary phenomenon contains an inertial component. The formulation of the problem leads to an application of the optimal control theory in which the state variable are the output gap and the rate of inflation, and the control variable is the growth rate of the money supply. The optimal monetary policy developed in the paper requires that at the outset of the stabilization program the monetary supply be diminished and that subsequently the rate of monetary growth be gradually reduced in the course of time.
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