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The Optimal Degree of Monetary-Discretion in a New Keynesian Model with Private Information

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  • WAKI Yuichiro
  • Richard DENNIS
  • FUJIWARA Ippei

Abstract

This paper considers the optimal degree of discretion in monetary policy when the central bank conducts policy based on its private information about the state of the economy and is unable to commit. Society seeks to maximize social welfare by imposing restrictions on the central bank's actions over time, and the central bank takes these restrictions and the New Keynesian Phillips curve as constraints. By solving a dynamic mechanism design problem we find that it is optimal to grant "constrained discretion" to the central bank by imposing both upper and lower bounds on permissible inflation, and that these bounds must be set in a history-dependent way. The optimal degree of discretion varies over time with the severity of the time-inconsistency problem, and, although no discretion is optimal when the time-inconsistency problem is very severe, our numerical experiment suggests that no-discretion is a transient phenomenon, and that some discretion is granted eventually.

Suggested Citation

  • WAKI Yuichiro & Richard DENNIS & FUJIWARA Ippei, 2015. "The Optimal Degree of Monetary-Discretion in a New Keynesian Model with Private Information," Discussion papers 15007, Research Institute of Economy, Trade and Industry (RIETI).
  • Handle: RePEc:eti:dpaper:15007
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    Cited by:

    1. Ippei Fujiwara & Yuichiro Waki, 2015. "Private news and monetary policy forward guidance or (the expected virtue of ignorance)," Globalization Institute Working Papers 238, Federal Reserve Bank of Dallas.
    2. Bassetto, Marco, 2019. "Forward guidance: Communication, commitment, or both?," Journal of Monetary Economics, Elsevier, vol. 108(C), pages 69-86.
    3. Timothy Hills & Taisuke Nakata & Takeki Sunakawa, 2021. "A Promised Value Approach to Optimal Monetary Policy," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 83(1), pages 176-198, February.
    4. Juan Passadore & Juan Xandri, 2019. "Robust Predictions in Dynamic Policy Games," 2019 Meeting Papers 1345, Society for Economic Dynamics.
    5. Gino Cateau & Malik Shukayev, 2018. "Limited Commitment, Endogenous Credibility and the Challenges of Price-level Targeting," Staff Working Papers 18-61, Bank of Canada.

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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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