Discretionary Monetary Policy in the Calvo Model

Abstract:     
We study discretionary equilibrium in the Calvo pricing model for a monetary authority that chooses the money supply. The steady-state inflation rate is above eight percent for a baseline calibration, and it varies non-monotonically with the degree of price stickiness. If the initial condition involves inflation higher than steady state, discretionary policy generates an immediate drop in inflation followed by a gradual increase to the steady state. Unlike the two-period Taylor model, discretionary policy in the Calvo model does not accommodate predetermined prices in a way that inevitably leads to multiple private-sector equilibria.

Number of Pages in PDF File: 31

Keywords: time-consisten monetary policy, relative price distortion, sticky prices, discretion

JEL Classification: E31, E52

working papers series