Discretionary Policy, Multiple Equilibria, and Monetary Instruments

34 Pages Posted: 22 Mar 2006

See all articles by Andreas Schabert

Andreas Schabert

University of Cologne - Department of Economics; University of Dortmund; University of Amsterdam - Faculty of Economics and Business

Multiple version iconThere are 3 versions of this paper

Date Written: December 2005

Abstract

This paper examines monetary policy implementation in a sticky price model. The central bank's plan under discretionary optimization is entirely forward-looking and exhibits multiple equilibrium solutions if transactions frictions are not negligibly small. The central bank can then implement stable history dependent equilibrium sequences that are consistent with its plan by inertial interest rate adjustments or by money transfers. These equilibria can be associated with lower welfare losses than a forward-looking solution implemented by interest rate adjustments. The welfare gain from a history dependent implementation tends to rise with the strength of transactions frictions and the degree of price flexibility. It is further shown that the central bank's plan can uniquely be implemented in a history dependent way by money transfers, whereas inertial interest rate adjustments cannot avoid equilibrium multiplicity.

Keywords: Monetary policy implementation, optimal discretionary policy, history dependence, equilibrium indeterminacy, money growth policy

JEL Classification: E32, E51, E52

Suggested Citation

Schabert, Andreas, Discretionary Policy, Multiple Equilibria, and Monetary Instruments (December 2005). CEPR Discussion Paper No. 5400. Available at SSRN: https://ssrn.com/abstract=892866

Andreas Schabert (Contact Author)

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany

University of Dortmund ( email )

Vogelpothsweg 87
Dortmund, 44227
Germany
+49 231 755 3288 (Phone)

University of Amsterdam - Faculty of Economics and Business ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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