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Monetary discretion, pricing complementarity and dynamic multiple equilibria

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  • King, Robert G.
  • Wolman, Alexander L.

Abstract

In a plain-vanilla New Keynesian model with two-period staggered price-setting, discretionary monetary policy leads to multiple equilibria. Complementarity between the pricing decisions of forward-looking firms underlies the multiplicity, which is intrinsically dynamic in nature. At each point in time, the discretionary monetary authority optimally accommodates the level of predetermined prices when setting the money supply because it is concerned solely about real activity. Hence, if other firms set a high price in the current period, an individual firm will optimally choose a high price because it knows that the monetary authority next period will accommodate with a high money supply. Under commitment, the mechanism generating complementarity is absent: the monetary authority commits not to respond to future predetermined prices. Multiple equilibria also arise in other similar contexts where (i) a policymaker cannot commit, and (ii) forward-looking agents determine a state variable to which future policy responds. --

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Bibliographic Info

Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2004/22.

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Date of creation: 2004
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Handle: RePEc:zbw:cfswop:200422

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Keywords: Monetary Policy; Discretion; Time-Consistency; Multiple Equilibria; Complementarity;

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  1. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  2. Miles S. Kimball & Michael Woodford, 1994. "The quantitative analysis of the basic neomonetarist model," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, pages 1241-1289.
  3. Huberto M. Ennis & Todd Keister, 2003. "Government Policy and the Probability of Coordination Failures," Working Papers, Centro de Investigacion Economica, ITAM 0301, Centro de Investigacion Economica, ITAM.
  4. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "Optimal monetary policy," Working Papers 01-5, Federal Reserve Bank of Philadelphia.
  5. Julio Rotemberg, 1987. "The New Keynesian Microfoundations," NBER Chapters, in: NBER Macroeconomics Annual 1987, Volume 2, pages 69-116 National Bureau of Economic Research, Inc.
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  7. V. V. Chari & Lawrence J. Christiano & Martin Eichenbaum, 1996. "Expectation Traps and Discretion," NBER Working Papers 5541, National Bureau of Economic Research, Inc.
  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, University of Chicago Press, vol. 85(3), pages 473-91, June.
  9. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
  10. Per Krusell & Jose-Victor Rios-Rull, 1997. "On the size of U.S. government: political economy in the neoclassical growth model," Staff Report, Federal Reserve Bank of Minneapolis 234, Federal Reserve Bank of Minneapolis.
  11. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(4), pages 589-610, August.
  12. Cooper, Russell & John, Andrew, 1988. "Coordinating Coordination Failures in Keynesian Models," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 103(3), pages 441-63, August.
  13. Glomm, Gerhard & Ravikumar, B., 1996. "Endogenous public policy and multiple equilibria," European Journal of Political Economy, Elsevier, Elsevier, vol. 11(4), pages 653-662, April.
  14. Ireland, Peter N., 1997. "Sustainable monetary policies," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 22(1), pages 87-108, November.
  15. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "The pitfalls of monetary discretion," Working Paper, Federal Reserve Bank of Richmond 01-08, Federal Reserve Bank of Richmond.
  16. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, American Economic Association, vol. 77(4), pages 647-66, September.
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