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Credible monetary policy with long-lived agents: recursive approaches

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  • Roberto Chang

Abstract

This paper develops recursive methods that completely characterize all the time-consistent equilibria of a class of models with long-lived agents. This class is large enough to encompass many problems of interest, such as capital-labor taxation and optimal monetary policy. The recursive methods obtained are intuitive and yield useful algorithms to compute the set of all time-consistent equilibria. ; These results are obtained by exploiting two key ideas derived from dynamic programming. The first--developed by Abreu, Pearce, and Stachetti in the context of repeated games and by Spear and Srivastava and Green in the context of dynamic principal agent problems--is that incentive constraints in infinite horizon models can be handled recursively by adding as a state variable the continuation value of the equilibrium. The second insight, due to Kydland and Prescott, is that the set of competitive equilibria of infinite horizon economies can often, in turn, be characterized recursively. ; I illustrate my methods by discussing optimal and credible monetary policy in a version of Calvo's (1978) model of time inconsistency. The set of time-consistent outcomes can be completely characterized as the largest fixed point of either of two well-defined operators, one motivated by Abreu, Pearce, and Stachetti (1990) and the other by Cronshaw and Luenberger (1994). In addition, recursive application of either of these two operators provides an algorithm that is shown to always converge to the set of time-consistent outcomes. Finally, the recursive method developed here yields valuable information about the nature of the time-inconsistency problem.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 96-20.

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Date of creation: 1996
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Publication status: Published in Journal of Economic Theory, August 1998
Handle: RePEc:fip:fedawp:96-20

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Keywords: Monetary policy;

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Cited by:
  1. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," Economics Working Papers ECO2011/15, European University Institute.
  2. Christopher Phelan & Ennio Stacchetti, 2001. "Sequential Equilibria in a Ramsey Tax Model," Econometrica, Econometric Society, vol. 69(6), pages 1491-1518, November.
  3. Ramon Marimon & Juan Pablo Nicolini & Pedro Teles, 1997. "Electronic money: the end of inflation?," Discussion Paper / Institute for Empirical Macroeconomics 122, Federal Reserve Bank of Minneapolis.
  4. Kasa, Kenneth, 1998. "Optimal policy with limited commitment," Journal of Economic Dynamics and Control, Elsevier, vol. 22(6), pages 887-910, June.
  5. Neiss, Katharine S, 1999. "Discretionary Inflation in a General Equilibrium Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 357-74, August.

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