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Discretion rather than rules? When is discretionary policy-making better than the timeless perspective?

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  • Sauer, Stephan
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    Abstract

    Discretionary monetary policy produces a dynamic loss in the New Keynesian model in the presence of cost-push shocks. The possibility to commit to a specific policy rule can increase welfare. A number of authors since Woodford (1999) have argued in favour of a timeless perspective rule as an optimal policy. The short-run costs associated with the timeless perspective are neglected in general, however. Rigid prices, relatively impatient households, a high preference of policy makers for output stabilisation and a deviation from the steady state all worsen the performance of the timeless perspective rule and can make it inferior to discretion. JEL Classification: E5

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    Bibliographic Info

    Paper provided by European Central Bank in its series Working Paper Series with number 0717.

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    Date of creation: Jan 2007
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    Handle: RePEc:ecb:ecbwps:20070717

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    Keywords: Optimality; Policy rules; Timeless perspective;

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    1. Bennett McCallum, 1999. "Role of the Minimal State Variable Criterion in Rational Expectations Models," International Tax and Public Finance, Springer, vol. 6(4), pages 621-639, November.
    2. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    3. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    4. Jinill Kim & Sunghyun Kim & Ernst Schaumburg & Christopher A. Sims, 2003. "Calculating and Using Second Order Accurate Solutions of Discrete Time," Levine's Bibliography 666156000000000284, UCLA Department of Economics.
    5. McCallum, Bennett T & Nelson, Edward, 2001. "Timeless Perspective Vs Discretionary Monetary Policy in Forward-Looking Models," CEPR Discussion Papers 2752, C.E.P.R. Discussion Papers.
    6. Andrew Levin & Jinill Kim, 2005. "Conditional Welfare Comparisons of Monetary Policy Rules," Computing in Economics and Finance 2005 148, Society for Computational Economics.
    7. Christian Jensen & Bennett C. McCallum, 2002. "The Non-Optimality of Proposed Monetary Policy Rules Under Timeless-Perspective Commitment," NBER Working Papers 8882, National Bureau of Economic Research, Inc.
    8. n/a, 2001. "A Timeless Perspective on Optimality in Forward-Looking Rational Expectations Models," NIESR Discussion Papers 154, National Institute of Economic and Social Research.
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