Incorporating Rigidity In The Timing Structure Of Macroeconomic Games
This paper proposes a simple framework that generalizes the timing structure of macroeconomic (as well as other) games. Building on alternative move games and models of "rational inattention" the players' actions may be rigid, ie optimally chosen to be infrequent. This rigidity makes the game more dynamic/asynchronous and by linking successive periods it can serve as commitment. Therefore, it can enhance cooperation and often eliminate inefficient equilibrium outcomes. We apply the framework to the Kydland-Prescott-Barro-Gordon monetraty policy game and dervice the conditions - the sufficient degree of commitment - under which the influential time-inconsistency problem disappears. Interestingly, (i) this can happen even in a finite game (possibly as short as two periods), (ii) the required degree of commitment may be rather (even infinitesimally) low and (iii) the policymaker's commitment may substitute for his conservatism and/or patience in achieving credibility. The analysis makes several predictions about explicit inflation targeting and central bank dependence (and their relationship) that we show to be empirically supported. In doing so we show that our theoretical results reconcile some conflicting empirical findings of the literature.
|Date of creation:||Apr 2007|
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- Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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- Backus, David & Driffill, John, 1985. "Rational Expectations and Policy Credibility Following a Change in Regime," Review of Economic Studies, Wiley Blackwell, vol. 52(2), pages 211-21, April.
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