Monetary Discretion, Pricing Complementarity and Dynamic Multiple Equilibria

55 Pages Posted: 25 Aug 2004

See all articles by Robert G. King

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

Multiple version iconThere are 4 versions of this paper

Date Written: April 2004

Abstract

In a plain-vanilla New Keynesian model with two-period staggered price-setting, discretionary monetary policy leads to multiple equilibria. Complementarity between pricing decisions of forward-looking firms underlies the multiplicity, which is intrinsically dynamic in nature. At each point in time, the discretionary monetary authority optimally accommodates the level of predetermined prices when setting the money supply because it is concerned solely about real activity. Hence, if other firms set a high price in the current period, an individual firm will optimally choose a high price because it knows that the monetary authority next period will accommodate with a high money supply. Under commitment, the mechanism generating complementarity is absent: the monetary authority commits not to respond to future predetermined prices. Multiple equilibria also arise in other similar contexts where (i) a policymaker cannot commit, and (ii) forward-looking agents determine a state variable to which future policy responds.

Keywords: Monetary policy, discretion, time-consistency, multiple equilibria, complementarity

JEL Classification: E5, E61, D78

Suggested Citation

King, Robert G. and Wolman, Alexander L., Monetary Discretion, Pricing Complementarity and Dynamic Multiple Equilibria (April 2004). ECB Working Paper No. 343. Available at SSRN: https://ssrn.com/abstract=532986

Robert G. King (Contact Author)

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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