IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this article or follow this journal

Expectation Traps and Discretion

  • Chari, V. V.
  • Christiano, Lawrence J.
  • Eichenbaum, Martin

We argue that discretionary monetary policy exposes the economy to welfare-decreasing instability. It does so by creating the potential for private expectations about the response of monetary policy to exogenous shocks to be self-fulfilling. Among the many equilibria that are possible, some have good welfare properties. But, others exhibit welfare decreasing volatility in output and employment. We refer to the latter type of equilibria as expectation traps. In effect, our paper presents a new argument for commitment in monetary policy because commitment eliminates these bad equilibria. We show that full commitment is not necessary to achieve the best outcome, and that more limited forms of commitment suffice.

(This abstract was borrowed from another version of this item.)

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.sciencedirect.com/science/article/B6WJ3-45J5B61-1P/2/2ad18221024579164a84383f4f391a31
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 81 (1998)
Issue (Month): 2 (August)
Pages: 462-492

as
in new window

Handle: RePEc:eee:jetheo:v:81:y:1998:i:2:p:462-492
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

References listed on IDEAS
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.:

as in new window
  1. Farmer Roger E. A. & Guo Jang-Ting, 1994. "Real Business Cycles and the Animal Spirits Hypothesis," Journal of Economic Theory, Elsevier, vol. 63(1), pages 42-72, June.
  2. Alan S. Blinder, 1982. "The Anatomy of Double-Digit Inflation in the 1970s," NBER Chapters, in: Inflation: Causes and Effects, pages 261-282 National Bureau of Economic Research, Inc.
  3. V. V. Chari & Patrick E. Kehoe, 1990. "Sustainable Plans and Mutual Default," IMF Working Papers 90/22, International Monetary Fund.
  4. Matsuyama, Kiminori, 1991. "Increasing Returns, Industrialization, and Indeterminacy of Equilibrium," The Quarterly Journal of Economics, MIT Press, vol. 106(2), pages 617-50, May.
  5. Chari, V V & Kehoe, Patrick J, 1990. "Sustainable Plans," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 783-802, August.
  6. Benhabib, Jess & Farmer, Roger E A, 1996. "Indeterminacy and Sector-specific Externalities," CEPR Discussion Papers 1403, C.E.P.R. Discussion Papers.
  7. Christiano, Lawrence J & Eichenbaum, Martin & Evans, Charles, 1996. "The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 16-34, February.
  8. Laurence Ball, 1991. "The genesis of inflation and the costs of disinflation," Proceedings, Federal Reserve Bank of Cleveland, pages 439-461.
  9. V.V. Chari, 1988. "Time consistency and optimal policy design," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 17-31.
  10. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects, monetary policy, and the business cycle," Discussion Paper / Institute for Empirical Macroeconomics 70, Federal Reserve Bank of Minneapolis.
  11. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  12. Abreu, Dilip, 1988. "On the Theory of Infinitely Repeated Games with Discounting," Econometrica, Econometric Society, vol. 56(2), pages 383-96, March.
  13. D. Backus & J. Driffil, 1998. "Inflation and Reputation," Levine's Working Paper Archive 625, David K. Levine.
  14. Ball, Laurence, 1995. "Time-consistent policy and persistent changes in inflation," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 329-350, November.
  15. Bryant, John, 1983. "A Simple Rational Expectations Keynes-Type Model," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 525-28, August.
  16. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  17. Chari V. V. & Kehoe Patrick J., 1993. "Sustainable Plans and Debt," Journal of Economic Theory, Elsevier, vol. 61(2), pages 230-261, December.
  18. Stokey, Nancy L., 1991. "Credible public policy," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 627-656, October.
  19. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  20. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  21. Calvo, Guillermo A, 1978. "On the Time Consistency of Optimal Policy in a Monetary Economy," Econometrica, Econometric Society, vol. 46(6), pages 1411-28, November.
  22. Bewley, Truman, 1983. "A Difficulty with the Optimum Quantity of Money," Econometrica, Econometric Society, vol. 51(5), pages 1485-504, September.
  23. Azariadis, Costas, 1981. "Self-fulfilling prophecies," Journal of Economic Theory, Elsevier, vol. 25(3), pages 380-396, December.
  24. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
  25. Arthur F. Burns, 1978. "Reflections of an Economic Policy Maker," Books, American Enterprise Institute, number 725136, 2.
  26. 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.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:eee:jetheo:v:81:y:1998:i:2:p:462-492. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.