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Optimal Time-Consistent Monetary Policy in the New Keynesian Model with Repeated Simultaneous Play

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  • Eric Swanson

    (Federal Reserve Bank of San Francisco)

  • Gauti Eggertsson

    (Federal Reserve Bank of New York)

Abstract

We solve for the optimal time-consistent monetary policy in the New Keynesian model with repeated simultaneous play between the monetary authority, households, and firms. Recent work on optimal time-consistent monetary policy has emphasized the existence of multiple Markov perfect equilibria in the New Keynesian model (e.g., King and Wolman, 2004). In this paper, we show that this multiplicity is not intrinsic to the New Keynesian model itself, but is instead driven by an auxiliary timing assumption by previous authors that play is “repeated Stackelberg”--in which the monetary authority must pre-commit each period to a value for the monetary instrument--as opposed to repeated simultaneous, in which the monetary authority and the private sector determine the economic equilibrium simultaneously and jointly each period. A contribution of our paper is to show how to define the game between the monetary authority, households, and firms with repeated simultaneous play and aggregate resource constraints. We show that the repeated simultaneous play assumption is the proper generalization of the large existing literature on linear-quadratic optimal monetary policy under uncertainty (e.g., Woodford, 2003, Svensson and Woodford, 2003, 2004). We highlight and discuss additional advantages of the repeated simultaneous play assumption. Finally, we derive a closed-form solution for the set of all possible Markov perfect equilibria in the two-period Taylor contracting version of the New Keynesian model with simultaneous play and show that the equilibrium in that model is unique.

Suggested Citation

  • Eric Swanson & Gauti Eggertsson, 2007. "Optimal Time-Consistent Monetary Policy in the New Keynesian Model with Repeated Simultaneous Play," 2007 Meeting Papers 214, Society for Economic Dynamics.
    • Handle: RePEc:red:sed007:214
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    References listed on IDEAS

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    1. Siu, Henry E., 2008. "Time consistent monetary policy with endogenous price rigidity," Journal of Economic Theory, Elsevier, vol. 138(1), pages 184-210, January.
    2. 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.
    3. Svensson, Lars E. O. & Woodford, Michael, 2003. "Indicator variables for optimal policy," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 691-720, April.
    4. Robert G. King & Alexander L. Wolman, 2004. "Monetary Discretion, Pricing Complementarity, and Dynamic Multiple Equilibria," The Quarterly Journal of Economics, Oxford University Press, vol. 119(4), pages 1513-1553.
    5. Pearlman, Joseph & Currie, David & Levine, Paul, 1986. "Rational expectations models with partial information," Economic Modelling, Elsevier, vol. 3(2), pages 90-105, April.
    6. King, Robert G. & Wolman, Alexander L., 2004. "Monetary discretion, pricing complementarity and dynamic multiple equilibria," Working Paper Series 343, European Central Bank.
    7. Christopher Phelan & Ennio Stacchetti, 2001. "Sequential Equilibria in a Ramsey Tax Model," Econometrica, Econometric Society, vol. 69(6), pages 1491-1518, November.
    8. Roc Armenter, 2008. "A General Theory (and Some Evidence) of Expectation Traps in Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(5), pages 867-895, August.
    9. Svensson, Lars E. O. & Woodford, Michael, 2004. "Indicator variables for optimal policy under asymmetric information," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 661-690, January.
    10. 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.
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