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Can the U.S. monetary policy fall (again) in an expectation trap?

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Author Info
Roc Armenter
Martin Bodenstein

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Abstract

We provide a tractable model to study monetary policy under discretion. We focus on Markov equilibria. For all parametrizations with an equilibrium inflation rate around 2%, there is a second equilibrium with an inflation rate just above 10%. Thus the model can simultaneously account for the low and high inflation episodes in the U.S. We carefully characterize the set of Markov equilibria along the parameter space and find our results to be robust.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 860.

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Date of creation: 2006
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Handle: RePEc:fip:fedgif:860

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Related research
Keywords: Inflation (Finance) ; Econometric models ; Equilibrium (Economics) ; Monetary policy;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Lawrence J. Christiano & Christopher Gust, 2000. "The expectations trap hypothesis," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q II, pages 21-39. [Downloadable!]
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  2. Stefania Albanesi & V. V. Chari & Lawrence J. Christiano, 2002. "Expectation Traps and Monetary Policy," Macroeconomics 0201004, EconWPA. [Downloadable!]
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  3. Domeij, David & Floden, Martin, 2001. "The labor-supply elasticity and borrowing constraints: Why estimates are biased," Working Paper Series in Economics and Finance 480, Stockholm School of Economics. [Downloadable!]
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  4. Rochet, Jean-Charles & Vives, Xavier, 2004. "Coordination Failures and the Lender of Last Resort : Was Bagehot Right After All?," IDEI Working Papers 294, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
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  5. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
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  6. Chari, V. V. & Christiano, Lawrence J. & Eichenbaum, Martin, 1998. "Expectation Traps and Discretion," Journal of Economic Theory, Elsevier, vol. 81(2), pages 462-492, August. [Downloadable!] (restricted)
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  7. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August. [Downloadable!] (restricted)
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  8. Roc Armenter, 2008. "A General Theory (and Some Evidence) of Expectation Traps in Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(5), pages 867-895, 08. [Downloadable!] (restricted)
  9. Roc Armenter & Martin Bodenstein, 2005. "Does the time inconsistency problem make flexible exchange rates look worse than you think?," Staff Reports 230, Federal Reserve Bank of New York. [Downloadable!]
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  10. Bernanke, Ben S. & Gertler, Mark & Waston, Mark, 1997. "Systematic Monetary Policy and the Effects of Oil Price Shocks," Working Papers 97-25, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
  11. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "The pitfalls of monetary discretion," Working Paper 01-08, Federal Reserve Bank of Richmond. [Downloadable!]
  12. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  13. Robert G. King & Alexander L.Wolman, 2004. "Monetary discretion, pricing complementarity and dynamic multiple equilibria," Working Paper Series 343, European Central Bank. [Downloadable!]
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  14. Morris, Stephen & Shin, Hyun Song, 2004. "Coordination risk and the price of debt," European Economic Review, Elsevier, vol. 48(1), pages 133-153, February. [Downloadable!] (restricted)
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  15. Dupor, Bill, 2003. "Optimal random monetary policy with nominal rigidity," Journal of Economic Theory, Elsevier, vol. 112(1), pages 66-78, September. [Downloadable!] (restricted)
  16. Albert Marcet & Juan P. Nicolini, 2003. "Recurrent Hyperinflations and Learning," American Economic Review, American Economic Association, vol. 93(5), pages 1476-1498, December. [Downloadable!]
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  17. 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. [Downloadable!] (restricted)
  18. Marvin Goodfriend & Robert G. King, 2005. "The Incredible Volcker Disinflation," Boston University - Department of Economics - Macroeconomics Working Papers Series WP2005-007, Boston University - Department of Economics. [Downloadable!]
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  1. Roc Armenter & Martin Bodenstein, 2006. "Does the time inconsistency problem make flexible exchange rates look worse than you think?," International Finance Discussion Papers 865, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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