Can U.S. Monetary Policy Fall (Again) into an Expectation Trap?

46 Pages Posted: 26 Nov 2005

See all articles by Roc Armenter

Roc Armenter

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Martin Bodenstein

Board of Governors of the Federal Reserve System

Date Written: May 2006

Abstract

We provide a tractable model to study monetary policy under discretion. We restrict our analysis to Markov equilibria. We find that for all parametrizations with an equilibrium inflation rate of about 2 percent, there is a second equilibrium with an inflation rate just above 10 percent. Thus, the model can simultaneously account for the low and high inflation episodes in the United States. We carefully characterize the set of Markov equilibria along the parameter space and find our results to be robust, suggesting that expectation traps are more than just a theoretical curiosity.

Keywords: expectation traps, monetary policy discretion, inflation

JEL Classification: E31, E52, E58

Suggested Citation

Armenter, Roc and Bodenstein, Martin, Can U.S. Monetary Policy Fall (Again) into an Expectation Trap? (May 2006). FRB of New York Staff Report No. 229; FRB International Finance Discussion Paper No. 860. Available at SSRN: https://ssrn.com/abstract=854204 or http://dx.doi.org/10.2139/ssrn.854204

Roc Armenter (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Martin Bodenstein

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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