The Pitfalls of Discretionary Monetary Policy

FRB of Philadelphia Working Paper No. 01-16

40 Pages Posted: 13 Jan 2002

See all articles by Aubhik Khan

Aubhik Khan

Ohio State University (OSU)

Robert G. King

Boston University - Department of Economics; Federal Reserve Bank of Richmond - Research Department; National Bureau of Economic Research (NBER)

Alexander L. Wolman

Federal Reserve Bank of Richmond

Date Written: October 2001

Abstract

In a canonical staggered pricing model, monetary discretion leads to multiple private sector equilibria. The basis for multiplicity is a form of policy complementarity. Specifically, prices set in the current period embed expectations about future policy, and actual future policy responds to these same prices. For a range of values of the fundamental state variable - a ratio of predetermined prices - there is complementarity between actual and expected policy, and multiple equilibria occur. Moreover, this multiplicity is not associated with reputational considerations: it occurs in a two-period model.

Keywords: discretion, time-consistency problem, optimal monetary policy, sticky prices, multiple equilibria

JEL Classification: E52, E51, E58, E31, E42

Suggested Citation

Khan, Aubhik and King, Robert G. and Wolman, Alexander L., The Pitfalls of Discretionary Monetary Policy (October 2001). FRB of Philadelphia Working Paper No. 01-16, Available at SSRN: https://ssrn.com/abstract=296540 or http://dx.doi.org/10.2139/ssrn.296540

Aubhik Khan (Contact Author)

Ohio State University (OSU) ( email )

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Robert G. King

Boston University - Department of Economics ( email )

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Federal Reserve Bank of Richmond - Research Department

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National Bureau of Economic Research (NBER)

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Alexander L. Wolman

Federal Reserve Bank of Richmond ( email )

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United States