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Expectations, Credibility, And Time-Consistent Monetary Policy

  • Ireland, Peter N.

This paper addresses the problem of multiple equilibria in a model of time-consistent monetary policy. It suggests that this problem originates in the assumption that agents have rational expectations and proposes several alternative restrictions on expectations that allow the monetary authority to build credibility for a disinflationary policy by demonstrating that it will stick to the policy even if it imposes short-run costs on the economy. Starting with these restrictions, the paper derives conditions that guarantee the uniqueness of the model's steady state; monetary policy in this unique steady state involves the constant deflation advocated by Milton Friedman.

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Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 4 (2000)
Issue (Month): 04 (December)
Pages: 448-466

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Handle: RePEc:cup:macdyn:v:4:y:2000:i:04:p:448-466_01
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  1. D. Backus & J. Driffil, 1998. "Inflation and Reputation," Levine's Working Paper Archive 625, David K. Levine.
  2. Robert J. Barro, 1986. "Reputation in a Model of Monetary Policy with Incomplete Information," NBER Working Papers 1794, National Bureau of Economic Research, Inc.
  3. Fuchs, Gerard, 1979. "Is error learning behaviour stabilizing?," Journal of Economic Theory, Elsevier, vol. 20(3), pages 300-317, June.
  4. Grandmont, Jean-Michel & Laroque, Guy, 1986. "Stability of cycles and expectations," Journal of Economic Theory, Elsevier, vol. 40(1), pages 138-151, October.
  5. Bennett T. McCallum, 1995. "Two Fallacies Concerning Central Bank Independence," NBER Working Papers 5075, National Bureau of Economic Research, Inc.
  6. Taylor, John B, 1982. "Establishing Credibility: A Rational Expectations Viewpoint," American Economic Review, American Economic Association, vol. 72(2), pages 81-85, May.
  7. Ireland, Peter N., 1997. "Sustainable monetary policies," Journal of Economic Dynamics and Control, Elsevier, vol. 22(1), pages 87-108, November.
  8. Ariel Rubinstein, 1997. "Finite automata play the repeated prisioners dilemma," Levine's Working Paper Archive 1639, David K. Levine.
  9. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  10. V. V. Chari & Patrick J Kehoe, 1998. "Sustainable Plans," Levine's Working Paper Archive 600, David K. Levine.
  11. Blackburn, Keith & Christensen, Michael, 1989. "Monetary Policy and Policy Credibility: Theories and Evidence," Journal of Economic Literature, American Economic Association, vol. 27(1), pages 1-45, March.
  12. Stokey, Nancy L., 1991. "Credible public policy," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 627-656, October.
  13. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
  14. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  15. 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.
  16. Fuchs, Gerard & Laroque, Guy, 1976. "Dynamics of Temporary Equilibria and Expectations," Econometrica, Econometric Society, vol. 44(6), pages 1157-78, November.
  17. Tillmann, Georg, 1983. "Stability in a simple pure consumption loan model," Journal of Economic Theory, Elsevier, vol. 30(2), pages 315-329, August.
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