Gradualism in Monetary Policy: A Time-Consistency Problem?

Jeremy C. Stein and Adi Sunderam

No 21569, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a model of monetary policy with two key features: (i) the central bank has private information about its long-run target for the policy rate; and (ii) the central bank is averse to bond-market volatility. In this setting, discretionary monetary policy is gradualist, or inertial, in the sense that the central bank only adjusts the policy rate slowly in response to changes in its privately-observed target. Such gradualism reflects an attempt to not spook the bond market. However, this effort ends up being thwarted in equilibrium, as long-term rates rationally react more to a given move in short rates when the central bank moves more gradually. The same desire to mitigate bond-market volatility can lead the central bank to lower short rates sharply when publicly-observed term premiums rise. In both cases, there is a time-consistency problem, and society would be better off appointing a central banker who cares less about the bond market. We also discuss the implications of our model for forward guidance once the economy is away from the zero lower bound.

JEL-codes: E44 E52 E58 (search for similar items in EconPapers)
Date: 2015-09
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Note: AP CF EFG ME
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Citations: View citations in EconPapers (6)

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