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Rules, Discretion and Reputation in a Model of Monetary Policy

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  • Robert J. Barro
  • David B. Gordon

Abstract

In a discretionary regime the monetary authority can print more money and create more inflation than people expect. But, although these inflation surprises can have some benefits, they cannot arise systematically in equilibrium when people understand the policymaker's incentives and form their expectations accordingly. Because the policymaker has the power to create inflation shocks ex post, the equilibrium growth rates of money and prices turn out to be higher than otherwise. Therefore, enforced commitments (rules) for monetary behavior can improve matters. Given the repeated interaction between the policymaker and the private agents, it is possible that reputational forces can substitute for formal rules.Here, we develop an example of a reputational equilibrium where the out-comes turn out to be weighted averages of those from discretion and those from the ideal rule. In particular, the rates of inflation and monetary growth look more like those under discretion when the discount rate is high.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1079.

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Date of creation: Feb 1983
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Publication status: published as Barro, Robert J. and David B. Gordon. "Rules, Discretion and Reputation ina Model of Monetary Policy." Journal of Monetary Economics, Vol. 12, No. 1,(July 1983), pp. 101-121.
Handle: RePEc:nbr:nberwo:1079

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  1. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 2(1), pages 1-32, January.
  2. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, Elsevier, vol. 2(2), pages 221-235, April.
  3. Taylor, John B, 1975. "Monetary Policy during a Transition to Rational Expectations," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 83(5), pages 1009-21, October.
  4. Friedman, James W, 1971. "A Non-cooperative Equilibrium for Supergames," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 38(113), pages 1-12, January.
  5. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(1), pages 191-205, February.
  6. Milgrom, Paul & Roberts, John, 1982. "Predation, reputation, and entry deterrence," Journal of Economic Theory, Elsevier, Elsevier, vol. 27(2), pages 280-312, August.
  7. Green, Edward J. & Porter, Robert H., 1982. "Noncooperative Collusion Under Imperfect Price Information," Working Papers, California Institute of Technology, Division of the Humanities and Social Sciences 367, California Institute of Technology, Division of the Humanities and Social Sciences.
  8. Friedman, Benjamin M., 1979. "Optimal expectations and the extreme information assumptions of `rational expectations' macromodels," Journal of Monetary Economics, Elsevier, Elsevier, vol. 5(1), pages 23-41, January.
  9. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(3), pages 473-91, June.
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