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An investigation of the gains from commitment in monetary policy
Authors:Ernst Schaumburg
Institution:a Kellogg Graduate School of Management, Northwestern University, Evanston, IL 60208, USA
b Federal Reserve Bank of New York , 33 Liberty Street, 3rd Floor, New York, NY 10045, USA
Abstract:We propose a simple framework for analyzing a continuum of monetary policy rules characterized by differing degrees of credibility, in which commitment and discretion become special cases of what we call quasi-commitment. The monetary policy authority is assumed to formulate optimal commitment plans, to be tempted to renege on them, and to succumb to this temptation with a constant exogenous probability known to the private sector. By interpreting this probability as a continuous measure of the (lack of) credibility of the monetary policy authority, we investigate the welfare effect of a marginal increase in credibility. Our main finding is that, in a simple model of the monetary transmission mechanism, most of the gains from commitment accrue at relatively low levels of credibility.
Keywords:E52  E58  E61
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