A General Theory (and Some Evidence) of Expectation Traps in Monetary Policy

Roc Armenter ()

Journal of Money, Credit and Banking, 2008, vol. 40, issue 5, pages 867-895

Abstract: I show that multiple equilibria are a general property of economies under full monetary policy discretion. Three simple conditions are sufficient to rule out, generically, a unique equilibrium in a static economy. The key departure from Barro and Gordon (1983) is to consider bounded welfare costs of inflation. I also show that in a two Markov equilibrium economy the inflation response to certain perturbations is, generically, qualitatively different in each equilibrium. Finally, I discuss some evidence on inflation dynamics that supports the hypothesis that U.S. monetary policy was caught in an expectation trap during the high inflation episode of the 1970s. Copyright (c) 2008 The Ohio State University.

Date: 2008
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