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The pitfalls of discretionary monetary policy

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  • Aubhik Khan
  • Robert G. King
  • Alexander L. Wolman

Abstract

In a canonical staggered pricing model, monetary discretion leads to multiple private sector equilibria. The basis for multiplicity is a form of policy complementarity. Specifically, prices set in the current period embed expectations about future policy, and actual future policy responds to these same prices. For a range of values of the fundamental state variable — a ratio of predetermined prices — there is complementarity between actual and expected policy, and multiple equilibria occur. Moreover, this multiplicity is not associated with reputational considerations: it occurs in a two-period model.

Suggested Citation

  • Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "The pitfalls of discretionary monetary policy," Working Papers 01-16, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:01-16
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    File URL: http://www.philadelphiafed.org/research-and-data/publications/working-papers/2001/wp01-16.pdf
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    References listed on IDEAS

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    1. Per Krusell & Anthony A. Smith, Jr., 2003. "Consumption--Savings Decisions with Quasi--Geometric Discounting," Econometrica, Econometric Society, vol. 71(1), pages 365-375, January.
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    3. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
    4. Chari, V. V. & Christiano, Lawrence J. & Eichenbaum, Martin, 1998. "Expectation Traps and Discretion," Journal of Economic Theory, Elsevier, vol. 81(2), pages 462-492, August.
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    6. Ireland, Peter N., 1997. "Sustainable monetary policies," Journal of Economic Dynamics and Control, Elsevier, vol. 22(1), pages 87-108, November.
    7. 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.
    8. Russell Cooper & Andrew John, 1988. "Coordinating Coordination Failures in Keynesian Models," The Quarterly Journal of Economics, Oxford University Press, vol. 103(3), pages 441-463.
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    12. 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 473-491, June.
    13. Huberto M. Ennis & Todd Keister, 2001. "Optimal policy with probabilistic equilibrium selection," Working Paper 01-03, Federal Reserve Bank of Richmond.
    14. Currie,David & Levine,Paul, 2009. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521104609.
    15. Alexander L. Wolman, 1999. "Sticky prices, marginal cost, and the behavior of inflation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 29-48.
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    Cited by:

    1. Willem Van Zandweghe & Alexander L. Wolman, 2010. "Discretionary monetary policy in the Calvo model," Research Working Paper RWP 10-06, Federal Reserve Bank of Kansas City.
    2. David Arseneau, 2012. "Expectation traps in a new Keynesian open economy model," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 49(1), pages 81-112, January.

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    Keywords

    Monetary policy;

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