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Expectation traps in a new Keynesian open economy model

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  • David Arseneau

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Abstract

This paper illustrates that the introduction of a money demand distortion into an otherwise standard New Keynesian Open Economy model generates multiple discretionary equilibria. These equilibria arise in the form of expectations traps whereby the monetary authority is trapped into validating expectations of the private sector because failing to do so is costly. One implication of the model is that provided initial inflation expectations are sufficiently anchored the global Friedman rule emerges as an equilibrium under discretion. It is therefore a time-consistent outcome and hence fully sustainable even in absence of a commitment device or reputational considerations.

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File URL: http://hdl.handle.net/10.1007/s00199-010-0533-2
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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 49 (2012)
Issue (Month): 1 (January)
Pages: 81-112

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Handle: RePEc:spr:joecth:v:49:y:2012:i:1:p:81-112

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Related research

Keywords: Discretionary monetary policy; Friedman rule; Time consistency problem; Sustainable policy; E58; E61; F41; F42;

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References

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Cited by:
  1. Zeng, Zhixiong, 2011. "A theory of the non-neutrality of money with banking frictions and bank recapitalization," MPRA Paper 33471, University Library of Munich, Germany.
  2. Evans, Richard W., 2012. "Is openness inflationary? Policy commitment and imperfect competition," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 1095-1110.

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