'Wet' or 'Impatient'? New Perspective on Discretionary Monetary Policymaking
22 Pages Posted: 25 Mar 2008
Date Written: January 8, 2008
We demonstrate the existence of multiple discretionary equilibria in a mainstream New Keynesian model with capital accumulation. There can be two monetary policy regimes, both of which satisfy conditions of optimality and time consistency. In a response to a cost-push shock one of the regimes can be characterised by large initial investment movements and slow adjustment of the capital stock back to the steady state that requires high interest rate, low inflation and large recession. The second regime does not allow large investment movements and delivers fast stabilisation of capital stock, but the policymaker has to create high inflation and small recession. Depending on the private sector's beliefs about the course of future policy one of these regimes prevails. These results imply that even a high relative weight on inflation stabilisation in policymaker's objectives cannot guarantee a "tough-on-inflation" discretionary policy. They also imply that most of proposed solutions to the "problem of optimal delegation" might have failed to deal with the problem of multiplicity.
Keywords: Time Consistency, Discretion, Multiple Equilibria
JEL Classification: E31, E52, E58, E61, C61
Suggested Citation: Suggested Citation