INCORPORATING RIGIDITY IN THE TIMING STRUCTURE OF MACROECONOMIC GAMES

Jan Libich and Petr Stehlik

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

Abstract: This paper proposes a simple framework that generalizes the timing structure of macroeconomic (as well as other) games. Building on alternating move games and models of ‘rational inattention’ the players’ actions may be rigid, ie optimally chosen to be infrequent. This rigidity makes the game more dynamic/asynchronous and by linking successive periods it can serve as commitment. Therefore, it can enhance cooperation and often eliminate inefficient equilibrium outcomes. We apply the framework to the Kydland-Prescott-Barro-Gordon monetary policy game and derive the conditions - the sufficient degree of commitment - under which the influential time-inconsistency problem disappears. Interestingly, (i) this can happen even in a finite game (possibly as short as two periods), (ii) the required degree of commitment may be rather (even infinitesimally) low and (iii) the policymaker’s commitment may substitute for his conservatism and/or patience in achieving credibility. The analysis makes several predictions about explicit inflation targeting and central bank independence (and their relationship) that we show to be empirically supported. In doing so we show that our theoretical results reconcile some conflicting empirical findings of the literature.

JEL-codes: C70 C72 E42 E61 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2007-04
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2007-10

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