Time inconsistency and reputation in monetary policy: a strategic model in continuous time

Jingyuan Li and Guoqiang Tian

MPRA Paper from University Library of Munich, Germany

Abstract: This article develops a model to examine the equilibrium behavior of the time inconsistency problem in a continuous time economy with stochastic and endogenized dis- tortion. First, the authors introduce the notion of sequentially rational equilibrium, and show that the time inconsistency problem may be solved with trigger reputation strategies for stochastic setting. The conditions for the existence of sequentially rational equilibrium are provided. Then, the concept of sequentially rational stochastically stable equilibrium is introduced. The authors compare the relative stability between the cooperative behavior and uncooperative behavior, and show that the cooperative equilibrium in this monetary policy game is a sequentially rational stochastically stable equilibrium and the uncooper- ative equilibrium is sequentially rational stochastically unstable equilibrium. In the long run, the zero inflation monetary policies are inherently more stable than the discretion rules, and once established, they tend to persist for longerperiods of the time.

Keywords: Time inconsistency; optimal stopping; stochastically stable equilibrium (search for similar items in EconPapers)
JEL-codes: E52 E58 (search for similar items in EconPapers)
Date: 2005-07-25
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Published in Acta Mathematica Scientia B(3).28(2008): pp. 697-710

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