IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper

How Important Is Precommitment for Monetary Policy?

  • Dennis, Richard

    ()

    (Federal Reserve Bank of San Francisco)

  • Söderström, Ulf

    ()

    (Research Department, Central Bank of Sweden)

Economic outcomes in dynamic economies with forward-looking agents depend crucially on whether or not the central bank can precommit, even in the absence of the traditional "inflation bias." This paper quantifies the welfare differential between precommitment and discretionary policy in both a stylized theoretical framework and in estimated data-consistent models. From the precommitment and discretionary solutions we calculate the permanent deviation of inflation from target that in welfare terms is equivalent to moving from discretion to precommitment, the "inflation equivalent." In the estimated models, using a range of reasonable central bank preference parameters, the "inflation equivalent" ranges from 0.05 to 3.6 percentage points, with a mid-point of either 0.15 or 1–1.5 percentage points, depending on the model. In addition to the degree of forward-looking behavior, we show that the existence of transmission lags and/or information lags is crucial for determining the welfare gain from precommitment.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.riksbank.com/upload/7066/wp_139.pdf
Download Restriction: no

Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 139.

as
in new window

Length: 37 pages
Date of creation: 01 Sep 2002
Date of revision:
Publication status: Forthcoming in Journal of Money, Credit, and Banking.
Handle: RePEc:hhs:rbnkwp:0139
Contact details of provider: Postal:
Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Phone: 08 - 787 00 00
Fax: 08-21 05 31
Web page: http://www.riksbank.com/
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  2. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  3. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  4. Jeffery D. Amato & Thomas Laubach, 2002. "Implications of habit formation for optimal monetary policy," BIS Working Papers 121, Bank for International Settlements.
  5. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  6. Nicoletta Batini & Richard Harrison & Stephen P. Millard, 2001. "Monetary policy rules for an open economy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  7. Coenen, Günter & Orphanides, Athanasios & Wieland, Volker, 2003. "Price stability and monetary policy effectiveness when nominal interest rates are bounded at zero," Working Paper Series 0231, European Central Bank.
  8. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  9. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  10. Bankim Chadha & Paul R. Masson & Guy Meredith, 1992. "Models of Inflation and the Costs of Disinflation," IMF Staff Papers, Palgrave Macmillan, vol. 39(2), pages 395-431, June.
  11. Kydland, Finn E. & Prescott, Edward C., 1980. "Dynamic optimal taxation, rational expectations and optimal control," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 79-91, May.
  12. Glenn D. Rudebusch, 2000. "Assessing nominal income rules for monetary policy with model and data uncertainty," Working Paper Series 2000-03, Federal Reserve Bank of San Francisco.
  13. Fuhrer, Jeffrey C, 1997. "Inflation/Output Variance Trade-Offs and Optimal Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(2), pages 214-34, May.
  14. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October.
  15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  16. Bennett T. McCallum, 1996. "Crucial Issues Concerning Central Bank Independence," NBER Working Papers 5597, National Bureau of Economic Research, Inc.
  17. Gerlach, Stefan & Smets, Frank, 1999. "Output gaps and monetary policy in the EMU area1," European Economic Review, Elsevier, vol. 43(4-6), pages 801-812, April.
  18. Svensson, Lars E O, 1997. "Optimal Inflation Targets, "Conservative" Central Banks, and Linear Inflation Contracts," American Economic Review, American Economic Association, vol. 87(1), pages 98-114, March.
  19. Andrew T. Levin & Volker W. Wieland & John C. Williams, 1998. "Robustness of simple monetary policy rules under model uncertainty," Finance and Economics Discussion Series 1998-45, Board of Governors of the Federal Reserve System (U.S.).
  20. Julio J. Rotemberg, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Oxford University Press, vol. 49(4), pages 517-531.
  21. Chan Guk Huh & Kevin J. Lansing, 1997. "Expectations, credibility, and disinflation in a small macroeconomic model," Working Paper 9713, Federal Reserve Bank of Cleveland.
  22. 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 473-91, June.
  23. Blake, Andrew P., 2002. "A 'Timeless Perspective' on Optimality in Forward-Looking Rational Expectations Models," Royal Economic Society Annual Conference 2002 30, Royal Economic Society.
  24. Bennett T. McCallum & Edward Nelson, 2000. "Timeless Perspectives vs. Discretionary Monetary Policy In Forward-Looking Models," NBER Working Papers 7915, National Bureau of Economic Research, Inc.
  25. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," NBER Working Papers 9419, National Bureau of Economic Research, Inc.
  26. Thomas J. Sargent & Noah Williams & Tao Zha, 2006. "The conquest of South American inflation," FRB Atlanta Working Paper 2006-20, Federal Reserve Bank of Atlanta.
  27. Marvin Goodfriend, 1990. "Interest rates and the conduct of monetary policy," Working Paper 90-06, Federal Reserve Bank of Richmond.
  28. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June.
  29. Arturo Extrella & Jeffrey C. Fuhrer, 1998. "Dynamic inconsistencies: counterfactual implications of a class of rational expectations models," Working Papers 98-5, Federal Reserve Bank of Boston.
  30. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper Series WP-01-08, Federal Reserve Bank of Chicago.
  31. Ehrmann, Michael & Smets, Frank, 2001. "Uncertain potential output: implications for monetary policy," Working Paper Series 0059, European Central Bank.
  32. Jensen, Henrik, 1999. "Targeting Nominal Income Growth or Inflation?," CEPR Discussion Papers 2341, C.E.P.R. Discussion Papers.
  33. Roberts, John M., 1997. "Is inflation sticky?," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 173-196, July.
  34. Fuhrer, Jeffrey C, 1997. "The (Un)Importance of Forward-Looking Behavior in Price Specifications," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 338-50, August.
  35. Fuhrer, Jeffrey C & Moore, George R, 1995. "Monetary Policy Trade-offs and the Correlation between Nominal Interest Rates and Real Output," American Economic Review, American Economic Association, vol. 85(1), pages 219-39, March.
  36. Richard Dennis, 2001. "Solving for Optimal Simple Rules in Rational Expectations Models," Computing in Economics and Finance 2001 30, Society for Computational Economics.
  37. Currie,David & Levine,Paul, 1993. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521441964, june. pag.
  38. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: II. Applications," Levine's Bibliography 506439000000000394, UCLA Department of Economics.
  39. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  40. Galí, Jordi & Gertler, Mark, 1999. "Inflation Dynamics: A Structural Economic Analysis," CEPR Discussion Papers 2246, C.E.P.R. Discussion Papers.
  41. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  42. Carl Walsh, 2003. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 93(1), pages 265-278, March.
  43. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  44. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608.
  45. Frank Smets & Raf Wouters, 2002. "Monetary policy in an estimated stochastic dynamic general equilibrium model of the Euro area," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  46. Peter N. Ireland, 1998. "Does the Time-Consistency Problem Explain the Behavior of Inflation in the United States?," Boston College Working Papers in Economics 415, Boston College Department of Economics.
  47. Orphanides, Athanasios & Wieland, Volker, 1999. "Inflation zone targeting," Working Paper Series 0008, European Central Bank.
  48. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  49. Alex Cukierman, 1989. "Why does the Fed smooth interest rates?," Proceedings, Federal Reserve Bank of St. Louis, pages 111-157.
  50. Buiter, Willem H & Jewitt, Ian, 1981. "Staggered Wage Setting with Real Wage Relativities: Variations on a Theme of Taylor," The Manchester School of Economic & Social Studies, University of Manchester, vol. 49(3), pages 211-28, September.
  51. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-86, September.
  52. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
  53. Laurence Ball, 1990. "Credible Disinflation with Staggered Price Setting," NBER Working Papers 3555, National Bureau of Economic Research, Inc.
  54. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: A General Approach," Levine's Bibliography 666156000000000246, UCLA Department of Economics.
  55. Nessén, Marianne & Vestin, David, 2000. "Average Inflation Targeting," Working Paper Series 119, Sveriges Riksbank (Central Bank of Sweden).
  56. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316.
  57. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
  58. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  59. Smets, Frank, 2000. "What horizon for price stability," Working Paper Series 0024, European Central Bank.
  60. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September.
  61. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
  62. Smets, Frank & Wouters, Raf, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 0171, European Central Bank.
  63. Jón Steinsson, 2000. "Optimal monetary policy in an economy with inflation persistence," Economics wp11, Department of Economics, Central bank of Iceland.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:hhs:rbnkwp:0139. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lena Löfgren)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.