Expectation Traps and Monetary Policy
Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
Varadarajan V. Chari
University of Minnesota - Twin Cities - Department of Economics; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)
Lawrence J. Christiano
Northwestern University; Federal Reserve Bank of Cleveland; Federal Reserve Bank of Chicago; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)
FRB of Chicago Working Paper No. 2002-04
Why is it that inflation is persistently high in some periods and persistently low in other periods? We argue that lack of commitment in monetary policy may bear a large part of the blame. We show that, in a standard equilibrium model, absence of commitment leads to multiple equilibria, or expectation traps. In these traps, expectations of high or low inflation lead the public to take defensive actions which then make it optimal for the monetary authority to validate those expectations. We find support in cross-country evidence for key implications of the model.
Number of Pages in PDF File: 60
JEL Classification: E5, E61, E63working papers series
Date posted: April 18, 2003
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