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Barro-Gordon Revisited: Reputational Equilibria in a New Keynesian Model

  • Hans-Werner Wohltmann

    (Christian-Albrechts- Universität zu Kiel, Institut für Volkswirtschaftslehre, Olshausenstraße 40, D-24118 Kiel)

  • Alexander Totzek

    (Christian-Albrechts- Universität zu Kiel, Institut für Volkswirtschaftslehre, Olshausenstraße 40, D-24118 Kiel)

The aim of this paper is to solve the inconsistency problem à la Barro/Gordon within a New Keynesian model and to derive time-consistent interest rate rules of Taylor-type. We find a multiplicity of time-consistent rules. In contrast to the famous Kydland/Prescott-Barro/Gordon approach, implementing a monetary rule where the cost and benefit resulting from inconsistent policy coincide – which implies a net gain of inconsistent policy behavior equal to zero – is not optimal. Instead, the solution can be improved by moving into the time-consistent area where the net gain of inconsistent policy is negative. When additionally considering a cost-push shock, the area of time-consistent simple rules of Taylor type becomes graphically smaller. Finally, we find that numerous estimated Taylor rules are time-inconsistent since the empirically observed coefficient on inflation is too low.

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Article provided by Credit and Capital Markets in its journal Kredit und Kapital.

Volume (Year): 45 (2012)
Issue (Month): 1 ()
Pages: 27–50

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Handle: RePEc:kuk:journl:v:45:y:2012:i:1:p:27-50
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  1. Bofinger, Peter & Mayer, Eric & Wollmershäuser, Timo, 2009. "Teaching New Keynesian Open Economy Macroeconomics at the Intermediate Level," Munich Reprints in Economics 20213, University of Munich, Department of Economics.
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  7. Bofinger, Peter & Mayer, Eric & Wollmershäuser, Timo, 2006. "The BMW model: A new framework for teaching monetary economics," Munich Reprints in Economics 20214, University of Munich, Department of Economics.
  8. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
  9. 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.
  10. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  11. Ireland, Peter N., 1999. "Does the time-consistency problem explain the behavior of inflation in the United States?," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 279-291, October.
  12. 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, vol. 91(4), pages 589-610, August.
  13. Dennis, Richard, 2010. "When is discretion superior to timeless perspective policymaking?," Journal of Monetary Economics, Elsevier, vol. 57(3), pages 266-277, April.
  14. Teruyoshi Kobayashi, 2008. "Incomplete Interest Rate Pass-Through and Optimal Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 4(3), pages 77-118, September.
  15. David Romer, 2000. "Keynesian Macroeconomics without the LM Curve," NBER Working Papers 7461, National Bureau of Economic Research, Inc.
  16. Yuki Teranishi, 2008. "Optimal Monetary Policy under Staggered Loan Contracts," IMES Discussion Paper Series 08-E-08, Institute for Monetary and Economic Studies, Bank of Japan.
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