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Monetary policy, expectations and commitment

  • Evans, George W.
  • Honkapohja, Seppo

Full commitment in monetary policy leads to equilibria that are superior to those from optimal discretionary policies. Different types of reactions functions to implement and instrument rules to approximate full commitment have been proposed in the literature. We assess optimal reaction functions and instrument rules, in terms of whether they lead to an RE equilibrium that is both locally determinate and stable under adaptive learning by private agents. The reaction function that appropriately depends explicitly on private expectations performs best on both counts. JEL Classification: E52, E31, D84

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Paper provided by European Central Bank in its series Working Paper Series with number 0124.

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Date of creation: Feb 2002
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Handle: RePEc:ecb:ecbwps:20020124
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  1. George W. Evans & Seppo Honkapohja, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," University of Oregon Economics Department Working Papers 2001-6, University of Oregon Economics Department, revised 03 Aug 2001.
  2. Lars E.O. Svensson, 1998. "Inflation Targeting as a Monetary Policy Rule," NBER Working Papers 6790, National Bureau of Economic Research, Inc.
  3. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  4. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  5. Honkapohja, Seppo & Mitra, Kaushik, 2004. "Are non-fundamental equilibria learnable in models of monetary policy?," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1743-1770, November.
  6. Bennett T. McCallum & Edward Nelson, 1998. "Performance of operational policy rules in an estimated semi-classical structural model," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  7. Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies.
  8. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  9. Evans, George W. & Honkapohja, Seppo & Marimon, Ramon, 1996. "Convergence in Monetary Inflation Models with Heterogeneous Learning Rules," CEPR Discussion Papers 1310, C.E.P.R. Discussion Papers.
  10. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 277-316.
  11. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
  12. Christian Jensen & Bennett C. McCallum, 2002. "The Non-Optimality of Proposed Monetary Policy Rules Under Timeless-Perspective Commitment," NBER Working Papers 8882, National Bureau of Economic Research, Inc.
  13. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  14. Lars E. O. Svensson, 2003. "What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," NBER Working Papers 9421, National Bureau of Economic Research, Inc.
  15. Ben S. Bernanke & Michael Woodford, 1997. "Inflation forecasts and monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 653-686.
  16. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  17. Bruce Preston, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
  18. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  19. McCallum, Bennett T & Nelson, Edward, 2001. "Timeless Perspective Vs Discretionary Monetary Policy in Forward-Looking Models," CEPR Discussion Papers 2752, C.E.P.R. Discussion Papers.
  20. Sargent, Thomas J., 1993. "Bounded Rationality in Macroeconomics: The Arne Ryde Memorial Lectures," OUP Catalogue, Oxford University Press, number 9780198288695, May.
  21. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
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