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Monetary discretion, pricing complementarity, and dynamic multiple equilibria

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  • Robert G. King
  • Alexander L. Wolman

Abstract

A discretionary policymaker responds to the state of the economy each period. Private agents' current behavior determines the future state based on expectations of future policy. Discretionary policy thus can lead to dynamic complementarity between private agents and a policymaker, which in turn can generate multiple equilibria. Working in a simple new Keynesian model with two-period staggered pricing ? in which equilibrium is unique under commitment ? we illustrate this interaction: if firms expect a high future money supply, (i) they will set a high current price and (ii) the future monetary authority will accommodate with a higher money supply, so as not to distort relative prices. We show that there are two point-in-time equilibria under discretion and we construct a related stochastic sunspot equilibrium.

Suggested Citation

  • Robert G. King & Alexander L. Wolman, 2004. "Monetary discretion, pricing complementarity, and dynamic multiple equilibria," Working Paper 04-05, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:04-05
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    References listed on IDEAS

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    More about this item

    Keywords

    Monetary policy;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation

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