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Expectation traps and monetary policy

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Author Info
Stefania Albanesi
V. V. Chari
Lawrence J. Christiano

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Abstract

Why is inflation persistently high in some periods and low in others? The reason may be absence of commitment in monetary policy. In a standard model, absence of commitment leads to multiple equilibria, or expectation traps, even without trigger strategies. In these traps, expectations of high or low inflation lead the public to take defensive actions, which then make accommodating those expectations the optimal monetary policy. Under commitment, the equilibrium is unique and the inflation rate is low on average. This analysis suggests that institutions which promote commitment can prevent high inflation episodes from recurring.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 319.

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Date of creation: 2003
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Publication status: Published in Review of Economic Studies> (Vol. 70, No. 4, October 2003, pp. 715-41)
Handle: RePEc:fip:fedmsr:319

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Keywords: Monetary policy Inflation (Finance) Consumer behavior

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  21. Rotemberg, Julio J., 1996. "Prices, output, and hours: An empirical analysis based on a sticky price model," Journal of Monetary Economics, Elsevier, vol. 37(3), pages 505-533, June. [Downloadable!] (restricted)
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  22. Peter N. Ireland, 1998. "Does the Time-Consistency Problem Explain the Behavior of Inflation in the United States?," Boston College Working Papers in Economics 415, Boston College Department of Economics. [Downloadable!]
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  23. Calvo, Guillermo A, 1978. "On the Time Consistency of Optimal Policy in a Monetary Economy," Econometrica, Econometric Society, vol. 46(6), pages 1411-28, November. [Downloadable!] (restricted)
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