A Positive Theory of Monetary Policy in a Natural Rate Model
Natural-rate models suggest that the systematic parts of monetary policy will not have important consequences for the business cycle. Nevertheless, we often observe high and variable rates of monetary growth, and a tendency for monetary authorities to pursue countercyclical policies. This behavior is shown to be consistent with a rational expectations equilibrium in a discretionary environment where the policymaker pursues a "reasonable" objective, but where precommitments on monetary growth are precluded. At each point in time, the policymaker optimizes subject to given inflationary expectations, which determine a Phillips Curve-type tradeoff between monetary growth/inflation and unemployment. Inflationary expectations are formed with the knowledge that policymakers will be in this situation. Accordingly, equilibrium excludes systematic deviations between actual and expected inflation, which means that the equilibrium unemployment rate ends up independent of "policy" in our model. However, the equilibrium rates of monetary growth/inflation depend on various parameters, including the slope of the Phillips Curve, the costs attached to unemployment versus inflation, and the level of the natural unemployment rate. The monetary authority determines an average inflation rate that is "excessive," and also tends to behave countercyclically. Outcomes are shown to improve if a costlessly operating rule is implemented in order to precomrnit future policy choices in the appropriate manner. The value of these precommitments -- that is, of long-term agreements between the government and the private sector -- underlies the argument for rules over discretion. Discretion is the sub-set of rules that provides no guarantees about the government's future behavior.
(This abstract was borrowed from another version of this item.)
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.:
- Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
- Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
- Hercowitz, Zvi, 1981.
"Money and the Dispersion of Relative Prices,"
Journal of Political Economy,
University of Chicago Press, vol. 89(2), pages 328-56, April.
- Friedman, James W, 1971. "A Non-cooperative Equilibrium for Supergames," Review of Economic Studies, Wiley Blackwell, vol. 38(113), pages 1-12, January.
- Auernheimer, Leonardo, 1974. "The Honest Government's Guide to the Revenue from the Creation of Money," Journal of Political Economy, University of Chicago Press, vol. 82(3), pages 598-606, May/June.
- Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
- Taylor, John B, 1975. "Monetary Policy during a Transition to Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 83(5), pages 1009-21, October.
- 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.
When requesting a correction, please mention this item's handle: RePEc:ucp:jpolec:v:91:y:1983:i:4:p:589-610. 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: (Journals Division)
If references are entirely missing, you can add them using this form.