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

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  • Roc Armenter
  • Martin Bodenstein

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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File URL: http://www.federalreserve.gov/pubs/ifdp/2006/860/ifdp860.pdf
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Bibliographic Info

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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References

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  1. 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.
  2. King, Robert G. & Wolman, Alexander L., 2004. "Monetary discretion, pricing complementarity and dynamic multiple equilibria," Working Paper Series 0343, European Central Bank.
  3. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
  4. Jean-Charles Rochet & Xavier Vives, 2002. "Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?," FMG Discussion Papers dp408, Financial Markets Group.
  5. Morris, Stephen & Shin, Hyun Song, 1997. "Unique Equilibrium in a Model of Self-fulfilling Currency Attacks," CEPR Discussion Papers 1687, C.E.P.R. Discussion Papers.
  6. 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.
  7. Marcet, A. & Nicolini, J.P., 1997. "Recurrent Hyperinflations and Learning," Papers 9721, Centro de Estudios Monetarios Y Financieros-.
  8. Dupor, Bill, 2003. "Optimal random monetary policy with nominal rigidity," Journal of Economic Theory, Elsevier, vol. 112(1), pages 66-78, September.
  9. 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.
  10. Morris, Stephen & Shin, Hyun Song, 2004. "Coordination risk and the price of debt," European Economic Review, Elsevier, vol. 48(1), pages 133-153, February.
  11. 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.
  12. Stefania Albanesi & V. V. Chari & Lawrence J. Christiano, 2003. "Expectation Traps and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 715-741.
  13. 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.
  14. Lawrence J. Christiano & Christopher Gust, 2000. "The expectations trap hypothesis," International Finance Discussion Papers 676, Board of Governors of the Federal Reserve System (U.S.).
  15. 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.
  16. 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.
  17. Robert J. Barro & David B. Gordon, 1983. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  18. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "The pitfalls of monetary discretion," Working Paper 01-08, Federal Reserve Bank of Richmond.
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Cited by:
  1. 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.

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