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Welfare Gains from Monetary Commitment in a Model of the Euro-Area

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  • Paul Levine

    ()
    (University of Surrey)

  • Peter McAdam

    (European Central Bank)

  • Joseph Pearlman

    (London Metropolitan University)

Abstract

This paper sets out first, to quantify the stabilization gains from commitment in terms of household welfare and second, to examine how commitment to an optimal or approximately optimal rule can be sustained as an equilibrium in which reneging hardly ever occurs. We utilize an influential empirical micro-founded DSGE model, the Euro-Area model of \cite{SW03}, and a quadratic approximation of the epresentative household's utility as the welfare criterion. We impose the effect of a lower zero nominal interest rate bound. In contrast with previous studies we find substantial stabilization gains from commitment -- as much as a $5-6\%$ permanent increase in consumption. We also find that a simple optimized commitment rule with the nominal interest rate responding to current inflation and the real wage closely mimics the optimal rule

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 403.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:403

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Keywords: Monetary rules; commitment; discretion; welfare gains;

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