Equilibrium monetary policy in a model of inflation and employment

Andrew P Blake ()

No 29, National Institute of Economic and Social Research (NIESR) Discussion Papers from National Institute of Economic and Social Research

Abstract: Questions of credibility and precommitment are now at the centre of debate about monetary policy, in the theoretical literature and also amongst those concerned with the design of a workable regime for this country following 'Black Wednesday'. In this paper, as in much of the debate, the crucial problem arises because the monetary authorities have an incentive to renege on their commitment to price stability, as this will result in lower unemployment at least for a spell. Various solutions have been proposed using different varieties of dynamic game theory‐the game being played between the authorities who try to choose the best precommitment strategy and economic agents in general who try to predict what policy, and hence inflation, will actually be. Previous contributions to the debate have made use of policy feedback rules, which the authorities might announce to indicate in advance how policy would respond to inflation or to unemployment. This paper uses instead the concept of 'open loop Nash equilibrium', which requires that the monetary authorities can make a commitment to the entire time path of inflation in the future. Within this framework the analysis is more tractable and the results less counter‐intuitive. The paper demonstrates the value of precommitment. Contact NIESR if copy required

Date: 1993-05
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