The optimal degree of discretion in monetary policy

Susan Athey (), Andrew Atkeson and Patrick J. Kehoe ()
Additional contact information
Susan Athey: Stanford University and National Bureau of Economic Research,Stanford University, Stanford, CA 94305-6072, USA., http://www.stanford.edu/~athey/

No 338, Working Paper Series from European Central Bank

Abstract: How much discretion should the monetary authority have in setting its policy? This question is analyzed in an economy with an agreed-upon social welfare function that depends on the randomly fluctuating state of the economy. The monetary authority has private information about that state. In the model, well-designed rules trade off society’s desire to give the monetary authority discretion to react to its private information against society’s need to guard against the time inconsistency problem arising from the temptation to stimulate the economy with unexpected inflation. Although this dynamic mechanism design problem seems complex, society can implement the optimal policy simply by legislating an inflation cap that specifies the highest allowable inflation rate. The more severe the time inconsistency problem, the more tightly the cap constrains policy and the smaller is the degree of discretion. As this problem becomes sufficiently severe, the optimal degree of discretion is none.

Keywords: Rules vs. discretion; time inconsistency; optimal monetary policy; inflation targets; inflation caps. (search for similar items in EconPapers)
JEL-codes: E5 E6 E52 E58 E61 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-fmk, nep-mac and nep-mon
Date: 2004-04
View list of references View citations in EconPapers

Downloads: (external link)
http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp338.pdf (application/pdf)

Related works:
Working Paper: The optimal degree of discretion in monetary policy (2002)
Working Paper: The optimal degree of discretion in monetary policy (2004)
Working Paper: The optimal degree of discretion in monetary policy (2004)
Working Paper: The Optimal Degree of Discretion in Monetary Policy (2003)
Journal Article: The Optimal Degree of Discretion in Monetary Policy (2005)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:ecb:ecbwps:20040338

Ordering information: This working paper can be ordered from
Press and Information Division, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany

Access Statistics for this paper

More papers in Working Paper Series from European Central Bank
Address: Postfach 16 03 19, Frankfurt am Main, Germany
Contact information at EDIRC.
Series data maintained by Official Publications ().