Expectation Traps and Discretion

Varadarajan Chari, Lawrence Christiano and Martin Eichenbaum

No 5541, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: E32 E60 (search for similar items in EconPapers)
Date: 1996-04
Note: EFG
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (47)

Published as Journal of Economic Theory, Vol. 81, no. 2 (August 1998): 462-492

Downloads: (external link)
http://www.nber.org/papers/w5541.pdf (application/pdf)

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:nbr:nberwo:5541

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w5541

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().