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Expectations, Credibility, and Time-Consistent Monetary Policy

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  • Peter N. Ireland

Abstract

This paper addresses the problem of multiple equilibria in a model of time-consistent monetary policy. It suggests that this problem originates in the assumption that agents have rational expectations and proposes several alternative restrictions on expectations that allow the monetary authority to build credibility for a disinflationary policy by demonstrating that it will stick to the policy even if it imposes short-run costs on the economy. Starting with these restrictions, the paper derives conditions that guarantee the uniqueness of the model's steady state; monetary policy in this unique steady state involves the constant deflation advocated by Milton Friedman.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7234.

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Date of creation: Jul 1999
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Publication status: published as Ireland, Peter N., 2000. "Expectations, Credibility, And Time-Consistent Monetary Policy," Macroeconomic Dynamics, Cambridge University Press, vol. 4(04), pages 448-466, December.
Handle: RePEc:nbr:nberwo:7234

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  1. V. V. Chari & Patrick J Kehoe, 1998. "Sustainable Plans," Levine's Working Paper Archive 600, David K. Levine.
  2. Ireland, Peter N., 1997. "Sustainable monetary policies," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 22(1), pages 87-108, November.
  3. Blackburn, Keith & Christensen, Michael, 1989. "Monetary Policy and Policy Credibility: Theories and Evidence," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 27(1), pages 1-45, March.
  4. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 18(2), pages 203-20, April.
  5. Fuchs, Gerard & Laroque, Guy, 1976. "Dynamics of Temporary Equilibria and Expectations," Econometrica, Econometric Society, Econometric Society, vol. 44(6), pages 1157-78, November.
  6. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, Elsevier, vol. 48(2), pages 337-368, August.
  7. Bennett T. McCallum, 1995. "Two Fallacies Concerning Central Bank Independence," NBER Working Papers 5075, National Bureau of Economic Research, Inc.
  8. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  9. David Backus & John Driffill, 1984. "Inflation and Reputation," Working Papers, Queen's University, Department of Economics 560, Queen's University, Department of Economics.
  10. Stokey, Nancy L., 1991. "Credible public policy," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 15(4), pages 627-656, October.
  11. Tillmann, Georg, 1983. "Stability in a simple pure consumption loan model," Journal of Economic Theory, Elsevier, Elsevier, vol. 30(2), pages 315-329, August.
  12. Barro, Robert J., 1986. "Reputation in a model of monetary policy with incomplete information," Journal of Monetary Economics, Elsevier, Elsevier, vol. 17(1), pages 3-20, January.
  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, University of Chicago Press, vol. 85(3), pages 473-91, June.
  14. Grandmont, Jean-Michel & Laroque, Guy, 1986. "Stability of cycles and expectations," Journal of Economic Theory, Elsevier, Elsevier, vol. 40(1), pages 138-151, October.
  15. Fuchs, Gerard, 1979. "Is error learning behaviour stabilizing?," Journal of Economic Theory, Elsevier, Elsevier, vol. 20(3), pages 300-317, June.
  16. Taylor, John B, 1982. "Establishing Credibility: A Rational Expectations Viewpoint," American Economic Review, American Economic Association, American Economic Association, vol. 72(2), pages 81-85, May.
  17. Rubinstein, Ariel, 1986. "Finite automata play the repeated prisoner's dilemma," Journal of Economic Theory, Elsevier, Elsevier, vol. 39(1), pages 83-96, June.
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