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, 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.

Date: 2008
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https://doi.org/10.1111/j.1538-4616.2008.00140.x

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Persistent link: https://EconPapers.repec.org/RePEc:wly:jmoncb:v:40:y:2008:i:5:p:867-895

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