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An Investigation of the Gains from Commitment in Monetary Policy

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Author Info
Ernst Schaumburg (Northwestern University)
Andrea Tambalotti (Princeton University)

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Abstract

This paper proposes a simple framework for analyzing a continuum of monetary policy rules characterized by differing degrees of credibility, in which commitment and discretion become special cases of what we call quasi commitment. The monetary policy authority is assumed to formulate optimal commitment plans, to be tempted to renege on them, and to succumb to this temptation with a constant exogenous probability known to the private sector. By interpreting this probability as a continuous measure of the (lack of) credibility of the monetary policy authority, we investigate the welfare effect of a marginal increase in credibility. Our main finding is that, in a simple model of the monetary transmission mechanism, most of the gains from commitment accrue at relatively low levels of credibility. In our benchmark calibration, a commitment expected to last for only 6 quarters is enough to bridge 75% of the welfare gap between discretion and commitment. This seems to justify the well known concern of monetary policy makers about their credibility, even in a world with limited access to commitment technologies.

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Paper provided by EconWPA in its series Macroeconomics with number 0302004.

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Length: 38 pages
Date of creation: 07 Feb 2003
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Handle: RePEc:wpa:wuwpma:0302004

Note: Type of Document - PDF; prepared on IBM PC ; pages: 38 ; figures: included
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Related research
Keywords: Commitment; discretion; credibility; welfare;

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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References listed on IDEAS
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Basso, Henrique S, 2008. "Delegation, Time Inconsistency and Sustainable Equilibrium," Working Paper Series 2008:15, Uppsala University, Department of Economics. [Downloadable!]
    Other versions:
  2. Nunes, Ricardo, 2008. "Delegation and Loose Commitment," MPRA Paper 11555, University Library of Munich, Germany. [Downloadable!]
  3. Davide Debortoli & Ricardo Nunes, 2008. "The macroeconomic effect of external pressures on monetary policy," International Finance Discussion Papers 944, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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    Other versions:
  8. A. Hakan Kara, 2004. "Optimal Monetary Policy, Commitment, and Imperfect Credibility," Central Bank Review, Research and Monetary Policy Department, Central Bank of the Republic of Turkey, vol. 4(1), pages 31-66. [Downloadable!]
  9. A. Hakan Kara, 2003. "Optimal Monetary Policy, Commitment, and Imperfect Credibility," Working Papers 0301, Research and Monetary Policy Department, Central Bank of the Republic of Turkey. [Downloadable!]
  10. Richard Dennis, 2009. "Timeless Perspective Policymaking: When is Discretion Superior?," NCER Working Paper Series 38, National Centre for Econometric Research. [Downloadable!]
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  11. Tokhir Mirzoev, 2004. "Limited Commitment, Inaction and Optimal Monetary Policy," Macroeconomics 0409027, EconWPA. [Downloadable!]
  12. Kenneth N. Kuttner & Adam S. Posen, 2007. "Do Markets Care Who Chairs the Central Bank?," Peterson Institute Working Paper Series WP07-3, Peterson Institute for International Economics. [Downloadable!]
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  13. Gauti B. Eggertsson & Benjamin Pugsley, 2007. "The Mistake of 1937: A General Equilibrium Analysis," CFS Working Paper Series 2007/06, Center for Financial Studies. [Downloadable!]
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  14. Hakan Kara, 2004. "Monetary Policy under Imperfect Commitment : Reconciling Theory with Evidence," Working Papers 0415, Research and Monetary Policy Department, Central Bank of the Republic of Turkey. [Downloadable!]
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  16. A. Hakan Kara, 2007. "Monetary Policy under Imperfect Commitment: Reconciling Theory with Evidence," International Journal of Central Banking, International Journal of Central Banking, vol. 3(1), pages 149-178, March. [Downloadable!]
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