Monetary Discretion, Pricing Complementarity, and Dynamic Multiple Equilibria
49 Pages Posted: 5 Dec 2012
Date Written: June 1, 2004
A discretionary policymaker responds to the state of the economy each period. Private agents' current behavior determines the future state based on expectations of future policy. Discretionary policy thus can lead to dynamic complementarity between private agents and a policymaker, which in turn can generate multiple equilibria. Working in a simple new Keynesian model with two-period staggered pricing — in which equilibrium is unique under commitment — we illustrate this interaction: if firms expect a high future money supply, (i) they will set a high current price and (ii) the future monetary authority will accommodate with a higher money supply, so as not to distort relative prices. We show that there are two point-in-time equilibria under discretion and we construct a related stochastic sunspot equilibrium.
Keywords: monetary policy, discretion, time-consistency, multiple equilibria, complementarity
JEL Classification: D78, E5, E61, E78
Suggested Citation: Suggested Citation