Gains from commitment in monetary policy: Implications of the cost channel

Ufuk Demirel

Journal of Macroeconomics, 2013, vol. 38, issue PB, 218-226

Abstract: Many empirical studies find robust evidence that marginal cost of production directly depends on the nominal rate of interest. This relationship induces a cost channel for monetary policy transmission. Although the empirical literature provides ample evidence for a cost channel, studies that evaluate the welfare gains from monetary policy commitment have so far entirely ignored its presence. This study shows that, overlooking the cost channel, one significantly underestimates the welfare gains from monetary policy commitment. I find that there is a robust positive relationship between the size of the cost channel and welfare gains from monetary policy commitment. Using a version of the new Keynesian model calibrated to the US economy, I find that failure to take into account the presence of a cost channel leads to an understatement of the gains from monetary policy commitment by an amount equivalent to a 0.48 percentage points permanent cut in quarterly inflation.

Keywords: Cost channel; Optimal monetary policy; Commitment; Discretion (search for similar items in EconPapers)
JEL-codes: E44 E52 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jmacro:v:38:y:2013:i:pb:p:218-226

DOI: 10.1016/j.jmacro.2013.06.005

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