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Expectations, Credibility, and Time-Consistent Monetary Policy

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  • Peter N. Ireland

    ()
    (Boston College)

Abstract

This paper addresses the problem of multiple equilibria in a model of time-consistent monetary policy. It suggests that this problem originates in the assumption that agents have rational expectations and proposes several alternative restrictions on expectations that allow the monetary authority to build credibility for a disinflationary policy by demonstrating that it will stick to that policy even if it imposes short-run costs on the economy. Starting with these restrictions, the paper derives conditions that guarantee the uniqueness of the model's steady state; monetary policy in this unique steady state involves the constant deflation advocated by Milton Friedman.

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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 425.

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Length: 42 pages
Date of creation: 09 Jul 1999
Date of revision:
Handle: RePEc:boc:bocoec:425

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Keywords: Time-consistency; Inflation; Credibility; Expectations;

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  1. Backus, David & Driffill, John, 1985. "Inflation and Reputation," American Economic Review, American Economic Association, vol. 75(3), pages 530-38, June.
  2. Blackburn, Keith & Christensen, Michael, 1989. "Monetary Policy and Policy Credibility: Theories and Evidence," Journal of Economic Literature, American Economic Association, vol. 27(1), pages 1-45, March.
  3. Stokey, Nancy L., 1991. "Credible public policy," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 15(4), pages 627-656, October.
  4. Rubinstein, Ariel, 1986. "Finite automata play the repeated prisoner's dilemma," Journal of Economic Theory, Elsevier, vol. 39(1), pages 83-96, June.
  5. McCallum, Bennett T, 1995. "Two Fallacies Concerning Central-Bank Independence," American Economic Review, American Economic Association, vol. 85(2), pages 207-11, May.
  6. Barro, Robert J., 1986. "Reputation in a model of monetary policy with incomplete information," Journal of Monetary Economics, Elsevier, Elsevier, vol. 17(1), pages 3-20, January.
  7. Grandmont, Jean-Michel & Laroque, Guy, 1986. "Stability of cycles and expectations," Journal of Economic Theory, Elsevier, vol. 40(1), pages 138-151, October.
  8. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 18(2), pages 203-20, April.
  9. Fuchs, Gerard, 1979. "Is error learning behaviour stabilizing?," Journal of Economic Theory, Elsevier, vol. 20(3), pages 300-317, June.
  10. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(3), pages 473-91, June.
  11. Tillmann, Georg, 1983. "Stability in a simple pure consumption loan model," Journal of Economic Theory, Elsevier, vol. 30(2), pages 315-329, August.
  12. Taylor, John B, 1982. "Establishing Credibility: A Rational Expectations Viewpoint," American Economic Review, American Economic Association, vol. 72(2), pages 81-85, May.
  13. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  14. Fuchs, Gerard & Laroque, Guy, 1976. "Dynamics of Temporary Equilibria and Expectations," Econometrica, Econometric Society, Econometric Society, vol. 44(6), pages 1157-78, November.
  15. V.V. Chari & Patrick J. Kehoe, 1989. "Sustainable plans," Staff Report, Federal Reserve Bank of Minneapolis 122, Federal Reserve Bank of Minneapolis.
  16. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(1), pages 101-121.
  17. Ireland, Peter N., 1997. "Sustainable monetary policies," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 22(1), pages 87-108, November.
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