The Pitfalls of Discretionary Monetary Policy

FRB of Philadelphia Working Paper No. 01-16

40 Pages Posted: 13 Jan 2002

See all articles by Aubhik Khan

Aubhik Khan

Ohio State University (OSU)

Robert G. King

Boston University - Department of Economics; Federal Reserve Bank of Richmond - Research Department; National Bureau of Economic Research (NBER)

Alexander L. Wolman

Federal Reserve Bank of Richmond

Date Written: October 2001

Abstract

In a canonical staggered pricing model, monetary discretion leads to multiple private sector equilibria. The basis for multiplicity is a form of policy complementarity. Specifically, prices set in the current period embed expectations about future policy, and actual future policy responds to these same prices. For a range of values of the fundamental state variable - a ratio of predetermined prices - there is complementarity between actual and expected policy, and multiple equilibria occur. Moreover, this multiplicity is not associated with reputational considerations: it occurs in a two-period model.

Keywords: discretion, time-consistency problem, optimal monetary policy, sticky prices, multiple equilibria

JEL Classification: E52, E51, E58, E31, E42

Suggested Citation

Khan, Aubhik and King, Robert G. and Wolman, Alexander L., The Pitfalls of Discretionary Monetary Policy (October 2001). FRB of Philadelphia Working Paper No. 01-16, Available at SSRN: https://ssrn.com/abstract=296540 or http://dx.doi.org/10.2139/ssrn.296540

Aubhik Khan (Contact Author)

Ohio State University (OSU) ( email )

2120 Fyffe Road
Columbus, OH OH 43210
United States

Robert G. King

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States
617-353-5941 (Phone)

Federal Reserve Bank of Richmond - Research Department

P.O. Box 27622
Richmond, VA 23261
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Alexander L. Wolman

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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