We extend the New Keynesian Monetary Policy literature relaxing the assumption that the decisionsare taken by a single policymaker, considering instead that monetary policy decisions are takencollectively in a committee. We introduce a Monetary Policy Committee (MPC), whose membershave different preferences between output and inflation variability and have to vote on the level of theinterest rate. This paper helps to explain interest rate smoothing from a political economy point ofview, in which MPC members face a bargaining problem on the level of the interest rate. In thisframework, the interest rate is a non-linear reaction function on the lagged interest rate and theexpected inflation. This result comes from a political equilibrium in which there is a strategicbehaviour of the agenda setter with respect to the rest of the MPC's members. Our approach can alsoreproduce both features documented by the empirical evidence on interest rate smoothing: a) themodest response of the interest rate to inflation and output gap; and b) the dependence on laggedinterest rate; features that are difficult to reproduce in standard New Keynesian models all together. Italso provides a theoretical framework on how disagreement among policymakers can slow down theadjustment on interest rates and on "menu costs" in interest rate decisions. Furthermore, a numericalexercise shows that this inertial behaviour of the interest rate is internalised by the economic agentsthrough an increase in expected inflation.
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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number
dp0780.
Find related papers by JEL classification: E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Models of Political Processes: Rent-seeking, Elections, Legislatures, and Voting Behavior
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