Can U.S. Monetary Policy Fall (Again) into an Expectation Trap?
46 Pages Posted: 26 Nov 2005
Date Written: May 2006
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: Suggested Citation