An Investigation of the Gains from Commitment in Monetary Policy

Ernst Schaumburg and Andrea Tambalotti ()
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Ernst Schaumburg: Northwestern University

Macroeconomics from EconWPA

Abstract: This paper proposes a simple framework for analyzing a continuum of monetary policy rules characterized by differing degrees of credibility, in which commitment and discretion become special cases of what we call quasi commitment. The monetary policy authority is assumed to formulate optimal commitment plans, to be tempted to renege on them, and to succumb to this temptation with a constant exogenous probability known to the private sector. By interpreting this probability as a continuous measure of the (lack of) credibility of the monetary policy authority, we investigate the welfare effect of a marginal increase in credibility. Our main finding is that, in a simple model of the monetary transmission mechanism, most of the gains from commitment accrue at relatively low levels of credibility. In our benchmark calibration, a commitment expected to last for only 6 quarters is enough to bridge 75% of the welfare gap between discretion and commitment. This seems to justify the well known concern of monetary policy makers about their credibility, even in a world with limited access to commitment technologies.

Keywords: Commitment; discretion; credibility; welfare (search for similar items in EconPapers)
JEL-codes: E52 E58 E61 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac, nep-mon and nep-pke
Date: Written 2003-02-07
Note: Type of Document - PDF; prepared on IBM PC ; pages: 38 ; figures: included
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http://129.3.20.41/eps/mac/papers/0302/0302004.pdf (application/pdf)

Related works:
Working Paper: An investigation of the gains from commitment in monetary policy (2003)
Working Paper: An Investigation of the Gains from Commitment in Monetary Policy (2004)
Journal Article: An investigation of the gains from commitment in monetary policy (2007)
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