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Quantifying and sustaining welfare gains from monetary commitment

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  • McAdam, Peter
  • Levine, Paul
  • Pearlman, Joseph G.

Abstract

The objectives of this paper are: first, to quantify the stabilization welfare gains from commitment; second, to examine how commitment to an optimal rule can be sustained as an equilibrium and third, to find a simple interest rate rule that closely approximates the optimal commitment one. We utilize an influential empirical micro-founded DSGE model, the euro area model of Smets and Wouters (2003), and a quadratic approximation of the representative household's utility as the welfare criterion. Importantly, we impose the effect of a nominal interest rate zero lower bound. In contrast with previous studies, we find significant stabilization gains from commitment: our central estimate is a 0.4 JEL Classification: E52, E37, E58

Suggested Citation

  • McAdam, Peter & Levine, Paul & Pearlman, Joseph G., 2007. "Quantifying and sustaining welfare gains from monetary commitment," Working Paper Series 709, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:2007709
    Note: 50336
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    More about this item

    Keywords

    commitment; discretion; Monetary rules; welfare gains.;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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