Expectation traps and discretion

Varadarajan Chari, Lawrence Christiano and Martin Eichenbaum

No WP-96-5, Working Paper Series, Macroeconomic Issues from Federal Reserve Bank of Chicago

Abstract: We argue that discretionary monetary policy exposes the economy to welfare-decreasing instability. It does so by creating the potential for private expectations about the response of monetary policy to exogenous shocks to be self-fulfilling. Among the many equilibria that are possible, some have good welfare properties. But, others exhibit welfare decreasing volatility in output and employment. We refer to the latter type of equilibria as expectation traps. In effect, our paper presents a new argument for commitment in monetary policy because commitment eliminates these bad equilibria. We show that full commitment is not necessary to achieve the best outcome, and that more limited forms of commitment suffice.

Keywords: Rational expectations (Economic theory); Monetary policy (search for similar items in EconPapers)
Date: 1996
References: Add references at CitEc
Citations: View citations in EconPapers (4)

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
Journal Article: Expectation Traps and Discretion (1998)
Working Paper: Expectations, traps and discretion (1996)
Working Paper: Expectation Traps and Discretion (1996)
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:fip:fedhma:wp-96-5

Ordering information: This working paper can be ordered from
publications.chi@chi.frb.org

Access Statistics for this paper

More papers in Working Paper Series, Macroeconomic Issues from Federal Reserve Bank of Chicago Contact information at EDIRC.
Bibliographic data for series maintained by Lauren Wiese (lauren.wiese@chi.frb.org).