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Escaping Expectation Traps: How Much Commitment is Required?

  • Christoph Himmels
  • Tatiana Kirsanova

In this paper we study the degree of precommitment that is required to eliminate multiplicity of policy equilibria, which arise if the policy maker acts under pure discretion. We apply a framework developed by Schaumburg and Tambalotti (2007) and Debortoli and Nunes (2010) to a standard New Keynesian model with government debt. We demonstrate the existence of expectation traps under limited commitment and identify the minimum degree of commitment which is needed to escape from these traps. We find that the degree of precommitment which is sufficient to generate uniqueness of the Pareto-preferred equilibrium requires the policy maker to stay in office for a period of two to five years. This is consistent with monetary policy arrangements in many developed countries.

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Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2012_18.

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Date of creation: Dec 2012
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Handle: RePEc:gla:glaewp:2012_18
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