Discretionary Monetary Policy in the Calvo Model
41 Pages Posted: 18 Dec 2012
Date Written: May 1, 2011
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 8 percent for a baseline calibration, but it varies substantially with alternative structural parameter values. 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.
Keywords: time-consistent optimal monetary policy, relative price distortion, sticky prices, discretion
JEL Classification: E31, E52
Suggested Citation: Suggested Citation