Too Little, Too Late? Monetary Policymaking Inertia and Psychology: A Behavioral Modeler

17 Pages Posted: 22 Feb 2016

See all articles by Federico Favaretto

Federico Favaretto

Bocconi University - BAFFI Center on International Markets, Money, and Regulation; University of Urbino

Donato Masciandaro

Bocconi University - Department of Economics; Bocconi University - Department of Economics (ECO)

Date Written: February 2016

Abstract

Can the inertia in the monetary policymaking be attributed to psychological drivers? Our model shows two results. First, our baseline model with individual loss aversion explains inertia in a monetary policy committee (MPC) where holds a de jure majority rule. Second, our second model shows that introducing a specification of loss aversion for all members in a MPC leads to inertial decisions when status-quo inflation is below the inflation target. Conversely when status-quo inflation is above the target rate, inertial policy does not occur until the level of inflation discounts the loss aversion mechanism. In the framework of a hawk-dove dimension we conclude that loss aversion favors inertial monetary policy.

Keywords: Monestary Policy, Behavorial Economics

JEL Classification: D7, E5

Suggested Citation

Favaretto, Federico and Masciandaro, Donato, Too Little, Too Late? Monetary Policymaking Inertia and Psychology: A Behavioral Modeler (February 2016). BAFFI CAREFIN Centre Research Paper No. 2016-17, Available at SSRN: https://ssrn.com/abstract=2736294 or http://dx.doi.org/10.2139/ssrn.2736294

Federico Favaretto

Bocconi University - BAFFI Center on International Markets, Money, and Regulation ( email )

Milano, 20136
Italy

University of Urbino ( email )

Via Saffi 2
Urbino, Pesaro-Urbino 61029
Italy

Donato Masciandaro (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Bocconi University - Department of Economics (ECO) ( email )

Via Gobbi 5
Milan, 20136
Italy

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