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The pitfalls of monetary discretion

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  • Aubhik Khan
  • Robert G. King
  • Alexander L. Wolman

Abstract

In a canonical staggered pricing model, monetary discretion leads to multiple private sector equilibria. The basis for multiplicity is a form of policy complementarity. Specifically, prices set in the current period embed expectations about future policy, and actual future policy responds to these same prices. For a range of values of the fundamental state variable ? a ratio of predetermined prices ? there is complementarity between actual and expected policy, and multiple equilibria occur. Moreover, this multiplicity is not associated with reputational considerations: it occurs in a two-period model.

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  • Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "The pitfalls of monetary discretion," Working Paper 01-08, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:01-08
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    References listed on IDEAS

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    3. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 70(4), pages 825-860.
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    5. 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.
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    11. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(s1), pages 1-35.
    12. Huberto M. Ennis & Todd Keister, 2001. "Optimal policy with probabilistic equilibrium selection," Working Paper 01-03, Federal Reserve Bank of Richmond.
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    Cited by:

    1. Armenter, Roc & Bodenstein, Martin, 2008. "Can The U.S. Monetary Policy Fall (Again) In An Expectation Trap?," Macroeconomic Dynamics, Cambridge University Press, vol. 12(5), pages 664-693, November.
    2. Robert G. King & Alexander L. Wolman, 2004. "Monetary Discretion, Pricing Complementarity, and Dynamic Multiple Equilibria," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 119(4), pages 1513-1553.
    3. Stefania Albanesi & V. V. Chari & Lawrence J. Christiano, 2003. "Expectation Traps and Monetary Policy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 70(4), pages 715-741.

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    Keywords

    Monetary policy; Prices; Equilibrium (Economics);
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