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The Importance of Commitment in the New Keynesian Model

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  • Jean-Paul Lam

    (Department of Economics, University of Waterloo)

Abstract

In the New Keynesian model, even if the central bank does not have an over-ambitious output target, policy under discretion leads to an inefficiency known as the stabilisation bias. In this paper, using a New Keynesian model, we explore and quantify how various uncertainties such as an information lag, a cost channel and multi-period data revisions affect the size of the stabilisation bias. When an information lag is introduced in an otherwise standard New Keynesian model, we find that the size of the stabilisation bias is considerably reduced. The presence of a cost-channel in the model, on the other hand, increases the stabilisation bias significantly. Finally, multi-period revisions to output and inflation, reduces the inefficiency associated with discretionary policy.

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File URL: http://economics.uwaterloo.ca/documents/10-008JPL.pdf
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Bibliographic Info

Paper provided by University of Waterloo, Department of Economics in its series Working Papers with number 1008.

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Length: 29 pages
Date of creation: Jul 2010
Date of revision: Jul 2010
Handle: RePEc:wat:wpaper:1008

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  1. Coenen, Gunter & Levin, Andrew & Wieland, Volker, 2005. "Data uncertainty and the role of money as an information variable for monetary policy," European Economic Review, Elsevier, Elsevier, vol. 49(4), pages 975-1006, May.
  2. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, The MIT Press, edition 2, volume 1, number 0262232316, December.
  3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  4. Lars E.O. Svensson & Michael Woodford, 2000. "Indicator variables for optimal policy," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco.
  5. Kilponen, Juha & Leitemo, Kai, 2011. "Transmission lags and optimal monetary policy," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 35(4), pages 565-578, April.
  6. Jeffery D. Amato & Thomas Laubach, 2002. "Rule-of-thumb behaviour and monetary policy," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2002-5, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Ali, Syed Zahid & Anwar, Sajid, 2013. "Inflation and interest rates in the presence of a cost channel, wealth effect and agent heterogeneity," Economic Modelling, Elsevier, Elsevier, vol. 31(C), pages 286-296.
  2. Matthias Lengnick & Hans-Werner Wohltmann, 2013. "Agent-based financial markets and New Keynesian macroeconomics: a synthesis," Journal of Economic Interaction and Coordination, Springer, Springer, vol. 8(1), pages 1-32, April.
  3. Esteban Pérez Caldentey & Matías Vernengo, 2013. "Is Inflation Targeting Operative in an Open Economy Setting?," Working Papers, Political Economy Research Institute, University of Massachusetts at Amherst wp324, Political Economy Research Institute, University of Massachusetts at Amherst.

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