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How Important is Precommitment for Monetary Policy?

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  • Ulf Soderstrom
  • Richard Dennis

Abstract

We quantify the welfare differential between precommitment and discretionary monetary policy in three estimated models of the U.S. economy by calculating the permanent deviation of inflation from target that in welfare terms is equivalent to moving from discretion to precommitment. Using a range of reasonable central bank preference parameters, this "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.
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Suggested Citation

  • Ulf Soderstrom & Richard Dennis, 2003. "How Important is Precommitment for Monetary Policy?," Computing in Economics and Finance 2003 49, Society for Computational Economics.
    • Handle: RePEc:sce:scecf3:49
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    More about this item

    Keywords

    Optimal Monetary Policy; Stabilization Bias; precommitment; discretion;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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