Monetary Policy When Preferences Are Quasi-Hyperbolic

51 Pages Posted: 24 Feb 2020

See all articles by Richard Dennis

Richard Dennis

University of Glasgow

Oleg Kirsanov

University of Glasgow

Date Written: February 21, 2020

Abstract

We study discretionary monetary policy in an economy where economic agents have quasi-hyperbolic discounting. We demonstrate that a benevolent central bank is able to keep inflation under control for a wide range of discount factors. If the central bank, however, does not adopt the household’s time preferences and tries to discourage early consumption and delayed-saving, then a marginal increase in steady state output is achieved at the cost of a much higher average inflation rate. Indeed, we show that it is desirable from a welfare perspective for the central bank to quasi-hyperbolically discount by more than households do. Welfare is improved because this discount structure emphasizes the current-period cost of price changes and leads to lower average inflation. We contrast our results with those obtained when policy is conducted according to a Taylor-type rule.

Keywords: Quasi-hyperbolic discounting, Monetary policy, Time-consistency

JEL Classification: E52, E61, C62, C73

Suggested Citation

Dennis, Richard and Kirsanov, Oleg, Monetary Policy When Preferences Are Quasi-Hyperbolic (February 21, 2020). CAMA Working Paper No. 14/2020, Available at SSRN: https://ssrn.com/abstract=3542054 or http://dx.doi.org/10.2139/ssrn.3542054

Richard Dennis (Contact Author)

University of Glasgow ( email )

Adam Smith Business School
Glasgow, Scotland G12 8LE
United Kingdom

Oleg Kirsanov

University of Glasgow ( email )

Adam Smith Business School
Glasgow, Scotland G12 8LE
United Kingdom

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