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Optimal Monetary Policy, Gains from Commitment, and Inflation Persistence

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  • André Minella

Abstract

Using a New Keynesian framework, this paper compares the effects on the welfare of optimal monetary policies under commitment and discretion, and examines the consequences of the presence of inflation persistence. A policy under commitment generates a better-weighted average of the variances of output and inflation ("dynamic gains"), and eliminates the inflationary bias. Commitment usually delivers a lower variance of inflation and a higher variance of output than those under discretion. The effect of the presence of inflation persistence on the dynamic gains from commitment is somehow surprising: the benefits are increasing in the degree of inflation persistence for moderate levels of persistence. On the other hand, inflation persistence reduces the inflationary bias. Furthermore, under "restricted commitment", were the solution is restricted to be within the same family of rules of the discretionary case, the gains are substantially inferior to those from commitment.

Suggested Citation

  • André Minella, 2002. "Optimal Monetary Policy, Gains from Commitment, and Inflation Persistence," Working Papers Series 45, Central Bank of Brazil, Research Department.
  • Handle: RePEc:bcb:wpaper:45
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    File URL: http://www.bcb.gov.br/pec/wps/ingl/wps45.pdf
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    1. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters,in: Monetary Policy Rules, pages 203-262 National Bureau of Economic Research, Inc.
    2. 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.
    3. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters,in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
    4. Bennett T. McCallum & Edward Nelson, 2004. "Timeless perspective vs. discretionary monetary policy in forward-looking models," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 43-56.
    5. John M. Roberts, 1998. "Inflation expectations and the transmission of monetary policy," Finance and Economics Discussion Series 1998-43, Board of Governors of the Federal Reserve System (U.S.).
    6. Roberts, John M., 1997. "Is inflation sticky?," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 173-196, July.
    7. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-984, November.
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