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Optimal Time-Consistent Monetary Policy in the New Keynesian Model with Repeated Simultaneous Play

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  • Eric Swanson

    (Federal Reserve Bank of San Francisco)

  • Gauti Eggertsson

    (Federal Reserve Bank of New York)

Abstract

We solve for the optimal time-consistent monetary policy in the New Keynesian model with repeated simultaneous play between the monetary authority, households, and firms. Recent work on optimal time-consistent monetary policy has emphasized the existence of multiple Markov perfect equilibria in the New Keynesian model (e.g., King and Wolman, 2004). In this paper, we show that this multiplicity is not intrinsic to the New Keynesian model itself, but is instead driven by an auxiliary timing assumption by previous authors that play is “repeated Stackelberg”--in which the monetary authority must pre-commit each period to a value for the monetary instrument--as opposed to repeated simultaneous, in which the monetary authority and the private sector determine the economic equilibrium simultaneously and jointly each period. A contribution of our paper is to show how to define the game between the monetary authority, households, and firms with repeated simultaneous play and aggregate resource constraints. We show that the repeated simultaneous play assumption is the proper generalization of the large existing literature on linear-quadratic optimal monetary policy under uncertainty (e.g., Woodford, 2003, Svensson and Woodford, 2003, 2004). We highlight and discuss additional advantages of the repeated simultaneous play assumption. Finally, we derive a closed-form solution for the set of all possible Markov perfect equilibria in the two-period Taylor contracting version of the New Keynesian model with simultaneous play and show that the equilibrium in that model is unique.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2007 Meeting Papers with number 214.

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Date of creation: 2007
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Handle: RePEc:red:sed007:214

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References

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  1. Henry Siu, 2005. "Time Consistent Monetary Policy with Endogenous Price Rigidity," 2005 Meeting Papers 821, Society for Economic Dynamics.
  2. Pearlman, Joseph G., 1992. "Reputational and nonreputational policies under partial information," Journal of Economic Dynamics and Control, Elsevier, vol. 16(2), pages 339-357, April.
  3. Svensson, Lars E. O. & Woodford, Michael, 2000. "Indicator variables for optimal policy," Working Paper Series 0012, European Central Bank.
  4. Bassetto, Marco, 2005. "Equilibrium and government commitment," Journal of Economic Theory, Elsevier, vol. 124(1), pages 79-105, September.
  5. Svensson, Lars E. O. & Woodford, Michael, 2004. "Indicator variables for optimal policy under asymmetric information," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 661-690, January.
  6. 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.
  7. Pearlman, Joseph & Currie, David & Levine, Paul, 1986. "Rational expectations models with partial information," Economic Modelling, Elsevier, vol. 3(2), pages 90-105, April.
  8. 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.
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Cited by:
  1. Taisuke Nakata, 2012. "Optimal Fiscal and Monetary Policy with Occasionally Binding Zero Bound Constraints," 2012 Meeting Papers 181, Society for Economic Dynamics.

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