IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Policy design with private sector skepticism in the textbook New Keynesian model

  • Yang Lu

    (Hong Kong University of Science and Technology)

  • Ernesto Pasten

    (Banco Central de Chile and Toulouse School of Economics)

  • Robert King

    (Boston University)

How should policy be optimally designed when a monetary authority faces a private sector that is somewhat skeptical about policy announcements and which interprets economic data as providing evidence about the monetary authority's preferences or its ability to carry through on policy plans? To provide an answer to this question, we extend the standard New Keynesian macroeconomic model to include imperfect inflation control (implementation error relative to an inflation action) and Bayesian learning by private agents about whether the monetary authority is the committed type (capable of following through on announced plans) or an alternative type (producing higher and more volatile inflation). In a benchmark case, we find that optimal policy involves dramatic anti-inflation actions which include an interval of deflation during the early stages of a plan, motivated by investing in a reputation for strength. Such policies resemble recommendations during the 1980s for a "cold turkey" approach to disinflation. However, we also find that such policy is not robustly optimal. A more "gradualist" policy arises if the initial level of credibility is very low. We also investigate a setting where the alternative monetary authority follows a simple behavioral rule that mimics variations in the committed authority's policy action but with a bias toward higher and more volatile inflation. In this case, which we call a "tag along" alternative policymaker, a form of gradualism is always optimal.

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: https://economicdynamics.org/meetpapers/2013/paper_241.pdf
Download Restriction: no

Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 241.

as
in new window

Length:
Date of creation: 2013
Date of revision:
Handle: RePEc:red:sed013:241
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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. Cukierman, A. & Liviatan, N., 1989. "Optimal Accommodation By Strong Policymakers Under Incomplete Information," Papers 13-89, Tel Aviv.
  2. V. V. Chari & Patrick J. Kehoe, 1989. "Sustainable plans and mutual default," Staff Report 124, Federal Reserve Bank of Minneapolis.
  3. Carl E. Walsh, 2002. "When should central bankers be fired?," Economics of Governance, Springer, vol. 3(1), pages 1-21, 03.
  4. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  5. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, March.
  6. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  7. V. V. Chari & Patrick J Kehoe, 1998. "Sustainable Plans," Levine's Working Paper Archive 600, David K. Levine.
  8. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
  9. Loisel, Olivier, 2008. "Central bank reputation in a forward-looking model," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3718-3742, November.
  10. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
  11. Aubhik Khan & Robert King & Alexander L. Wolman, 2002. "Optimal monetary policy," Working Papers 02-19, Federal Reserve Bank of Philadelphia.
  12. Roberds, William, 1987. "Models of Policy under Stochastic Replanning," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 731-55, October.
  13. Mailath,G.J. & Samuelson,L., 1998. "Who wants a good reputation?," Working papers 19, Wisconsin Madison - Social Systems.
  14. Martin W. Cripps & George J. Mailath & Larry Samuelson, 2004. "Imperfect Monitoring and Impermanent Reputations," Econometrica, Econometric Society, vol. 72(2), pages 407-432, 03.
  15. Jordi Galí & Mark Gertler, 2007. "Macroeconomic Modeling for Monetary Policy Evaluation," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 25-46, Fall.
  16. Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Working Papers 050608, University of California-Irvine, Department of Economics.
  17. Yang K. Lu & Ernesto Pasten & Robert G. King, 2008. "Managing expectations," 2008 Meeting Papers 959, Society for Economic Dynamics.
  18. John H. Cochrane, 2011. "Determinacy and Identification with Taylor Rules," Journal of Political Economy, University of Chicago Press, vol. 119(3), pages 565 - 615.
  19. Ernst Schaumburg & Andrea Tambalotti, 2003. "An Investigation of the Gains from Commitment in Monetary Policy," Macroeconomics 0302004, EconWPA.
  20. Debortoli, Davide & Nunes, Ricardo, 2010. "Fiscal policy under loose commitment," Journal of Economic Theory, Elsevier, vol. 145(3), pages 1005-1032, May.
  21. Drew Fudenberg & David K. Levine & Eric Maskin, 1994. "The Folk Theorem with Imperfect Public Information," Levine's Working Paper Archive 2058, David K. Levine.
  22. Francesco Bianchi, 2012. "Evolving Monetary/Fiscal Policy Mix in the United States," American Economic Review, American Economic Association, vol. 102(3), pages 167-72, May.
  23. Jordi Galí, 2008. "Introduction to Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework," Introductory Chapters, in: Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework Princeton University Press.
  24. Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September.
  25. Christian Matthes & Argia M. Sbordone & Timothy Cogley, 2011. "Optimal Disinflation Under Learning," 2011 Meeting Papers 74, Society for Economic Dynamics.
  26. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  27. Frank Schorfheide, 2003. "Learning and monetary policy shifts," FRB Atlanta Working Paper 2003-23, Federal Reserve Bank of Atlanta.
  28. David Backus & John Driffill, 1985. "Rational Expectations and Policy Credibility Following a Change in Regime," Review of Economic Studies, Oxford University Press, vol. 52(2), pages 211-221.
  29. Baxter, Marianne, 1985. "The role of expectations in stabilization policy," Journal of Monetary Economics, Elsevier, vol. 15(3), pages 343-362, May.
  30. Lu, Yang K., 2013. "Optimal policy with credibility concerns," Journal of Economic Theory, Elsevier, vol. 148(5), pages 2007-2032.
  31. Elmar Mertens, 2010. "Managing beliefs about monetary policy under discretion," Finance and Economics Discussion Series 2010-11, Board of Governors of the Federal Reserve System (U.S.).
  32. Davide Debortoli & Ricardo Nunes, 2013. "Lack Of Commitment And The Level Of Debt," Journal of the European Economic Association, European Economic Association, vol. 11(5), pages 1053-1078, October.
  33. Kurozumi, Takushi, 2008. "Optimal sustainable monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(7), pages 1277-1289, October.
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:red:sed013:241. 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: (Christian Zimmermann)

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.