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Credibility and the value of information transmission in a model of monetary policy and inflation

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  • Basar, Tamer
  • Salmon, Mark

Abstract

In this paper we solve for the optimal (Stickler) policy in a model of credibility and monetary policy developed by Cuckierman and Meltzer (1986). Unlike the (Nash) solution provided by Cuckierman and Meltzer the dynamic optimisation problem facing the monetary authority in this case is not a linear quadratic form and certainly equivalence does not apply. The learning behaviour of the private sector (regarding the policy maker's preferences) becomes intimately linked with the choice of the optimal policy and cannot be separated as in the certainty equivalent case. Once the dual effect of the optimal Stackelberg policy is recognised the monetary authority has an additional channel of influence to consider beyond that taken into policy rules. Unlike Nash behaviour the Stackelberg solution implies no inflationary bias but it lacks credibility. The learning behaviour of the private sector does not sufficiently inhibit the incentive of the monetary authority to cheat in this model despite the fact that this learning is explicitly recognised in the Stackelberg solution.
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  • Basar, Tamer & Salmon, Mark, 1990. "Credibility and the value of information transmission in a model of monetary policy and inflation," Journal of Economic Dynamics and Control, Elsevier, vol. 14(1), pages 97-116, February.
    • Handle: RePEc:eee:dyncon:v:14:y:1990:i:1:p:97-116
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    1. Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September.
    2. Daniel Cohen & Philippe Michel, 1988. "How Should Control Theory Be Used to Calculate a Time-Consistent Government Policy?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 55(2), pages 263-274.
    3. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
    4. Cripps, Martin, 1988. "Learning Rational Expectations In A Policy Game," The Warwick Economics Research Paper Series (TWERPS) 297, University of Warwick, Department of Economics.
    5. 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 473-491, June.
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    Cited by:

    1. Ellison, Martin & Sarno, Lucio & Vilmunen, Jouko, 2004. "Monetary policy and learning in an open economy," Bank of Finland Research Discussion Papers 3/2004, Bank of Finland.
    2. Wieland, Volker, 2000. "Monetary policy, parameter uncertainty and optimal learning," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 199-228, August.
    3. Ulf Söderström, 2002. "Monetary Policy with Uncertain Parameters," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(1), pages 125-145, March.
    4. António Caleiro, 2005. "How to Classify a Government? Can a Neural Network do it?," Economics Working Papers 9_2005, University of Évora, Department of Economics (Portugal).
    5. Ellison, Martin & Sarno, Lucio & Vilmunen, Jouko, 2007. "Caution Or Activism? Monetary Policy Strategies In An Open Economy," Macroeconomic Dynamics, Cambridge University Press, vol. 11(4), pages 519-541, September.
    6. Cripps, Martin, 1988. "Learning Rational Expectations In A Policy Game," The Warwick Economics Research Paper Series (TWERPS) 297, University of Warwick, Department of Economics.
    7. Soderstrom, Ulf, 2002. " Monetary Policy with Uncertain Parameters," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(1), pages 125-145.
    8. Felipe Morandé & Mauricio Tejada, 2008. "Sources of Uncertainty for Conducting Monetary Policy in Chile," Working Papers Central Bank of Chile 492, Central Bank of Chile.
    9. Geraats, Petra Maria, 2001. "Precommitment, Transparency and Monetary Policy," Discussion Paper Series 1: Economic Studies 2001,12, Deutsche Bundesbank.
    10. Felipe Morandé L. & Mauricio Tejada G., 2008. "Sources of Uncertainty in Monetary Policy Conduct in Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 11(3), pages 45-80, December.

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