The optimal degree of discretion in monetary policy

Susan Athey, Andrew Atkeson and Patrick Kehoe

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. JEL Classification: E5, E6, E52, E58, E61

Keywords: inflation caps; inflation targets; optimal monetary policy; rules vs. discretion; time inconsistency (search for similar items in EconPapers)
Date: 2004-04
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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

Related works:
Journal Article: The Optimal Degree of Discretion in Monetary Policy (2005)
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)
Working Paper: The optimal degree of discretion in monetary policy (2002)
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: https://EconPapers.repec.org/RePEc:ecb:ecbwps:2004338

Access Statistics for this paper

More papers in Working Paper Series from European Central Bank 60640 Frankfurt am Main, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Official Publications ().