Discretion and the Transmission Lags of Monetary Policy

27 Pages Posted: 24 Aug 2007

See all articles by Juha Kilponen

Juha Kilponen

Bank of Finland - Research

Kai Leitemo

Norwegian School of Management


Monetary policy transmission lags create credibility problems for the inflation-targeting policy maker who acts under discretion. We show that if prices react to monetary policy with a longer lag than output, the welfare maximizing inflation-targeting policy implies no policy stabilization of cost-push shocks in the canonical New Keynesian model. The reason is simple: for the period monetary policy influences output, inflation is predetermined and the best discretionary policy is to stabilize the output gap fully. We find that money growth targeting comes close to replicating the welfare-maximizing policy under commitment if there are transmission lags.

Keywords: discretionary and stabilization bias, monetary policy, transmission lags, inflation targeting, money targeting

JEL Classification: E52, E58, E61

Suggested Citation

Kilponen, Juha and Leitemo, Kai, Discretion and the Transmission Lags of Monetary Policy. Bank of Finland Research Discussion Paper No. 8/2007. Available at SSRN: https://ssrn.com/abstract=1008747 or http://dx.doi.org/10.2139/ssrn.1008747

Juha Kilponen (Contact Author)

Bank of Finland - Research ( email )

P.O. Box 160
FIN-00101 Helsinki
+358 10 831 2847 (Phone)
+358 10 831 2294 (Fax)

HOME PAGE: http://www.bof.fi/en/suomen_pankki/organisaatio/asiantuntijoita/kilponen_juha/

Kai Leitemo

Norwegian School of Management ( email )

P.O. Box 580
N-1302 Sandvika
+47 6755 7477 (Phone)
+47 6755 7675 (Fax)

HOME PAGE: http://economics.no

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