Optimal Monetary Policy, Gains from Commitment, and Inflation Persistence

Banco Central do Brasil Working Paper No. 45

67 Pages Posted: 4 Feb 2003

Date Written: August 2002

Abstract

Using a New Keynesian framework, this paper compares the effects on the welfare of optimal monetary policies under commitment and discretion, and examines the consequences of the presence of inflation persistence. A policy under commitment generates a better weighted average of the variances of output and inflation ("dynamic gains"), and eliminates the inflationary bias. Commitment usually delivers a lower variance of inflation and a higher variance of output than those under discretion. The effect of the presence of inflation persistence on the dynamic gains from commitment is somehow surprising: the benefits are increasing in the degree of inflation persistence for moderate levels of persistence. On the other hand, inflation persistence reduces the inflationary bias. Furthermore, under "restricted commitment", where the solution is restricted to be within the same family of rules of the discretionary case, the gains are substantially inferior to those from commitment.

Keywords: optimal monetary policy, commitment, discretion, inflation persistence

JEL Classification: E31, E52

Suggested Citation

Minella, Andre, Optimal Monetary Policy, Gains from Commitment, and Inflation Persistence (August 2002). Banco Central do Brasil Working Paper No. 45, Available at SSRN: https://ssrn.com/abstract=353681 or http://dx.doi.org/10.2139/ssrn.353681

Andre Minella (Contact Author)

Central Bank of Brazil ( email )

SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70.000-000 DF 70074
Brazil
+55 61 414 3653 (Phone)
+55 61 226 0767 (Fax)

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