Quantifying and Sustaining Welfare Gains from Monetary Commitment

70 Pages Posted: 16 Jan 2007

See all articles by Paul Levine

Paul Levine

School of Economics, University of Surrey

Peter McAdam

European Central Bank (ECB); University of Surrey, Economics

Joseph Pearlman

London Metropolitan University - Department of Economics, Finance and International Business (EFIB)

Date Written: January 2007

Abstract

The objectives of this paper are: first, to quantify the stabilization welfare gains from commitment; second, to examine how commitment to an optimal rule can be sustained as an equilibrium and third, to find a simple interest rate rule that closely approximates the optimal commitment one. We utilize an influential empirical micro-founded DSGE model, the euro area model of Smets and Wouters (2003), and a quadratic approximation of the representative household's utility as the welfare criterion. Importantly, we impose the effect of a nominal interest rate zero lower bound. In contrast with previous studies, we find significant stabilization gains from commitment: our central estimate is a 0.4 - 0.5% equivalent permanent increase in consumption, but in a variant with a higher degree of price stickiness, gains of over 2% are found. We also find that a simple optimized commitment rule with the nominal interest rate responding to current inflation and the real wage closely mimics the optimal rule.

Keywords: Monetary rules, commitment, discretion, welfare gains

JEL Classification: E52, E37, E58

Suggested Citation

Levine, Paul L. and McAdam, Peter and Pearlman, Joseph G., Quantifying and Sustaining Welfare Gains from Monetary Commitment (January 2007). ECB Working Paper No. 709. Available at SSRN: https://ssrn.com/abstract=954702

Paul L. Levine (Contact Author)

School of Economics, University of Surrey ( email )

Guildford
Surrey GU2 7XH
United Kingdom
+44 1483 259 380 Ext. 2773 (Phone)
+44 1483 259 548 (Fax)

Peter McAdam

European Central Bank (ECB) ( email )

Kaiserstrasse 29
Eurotower
D-60311 Frankfurt am Main
Germany
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

University of Surrey, Economics ( email )

Guildford
Guildford, Surrey GU2 5XH
United Kingdom

Joseph G. Pearlman

London Metropolitan University - Department of Economics, Finance and International Business (EFIB) ( email )

Economics Subject Group, LMBS
London EC2M 6SQ, EC2M 6SQ
United Kingdom

Register to save articles to
your library

Register

Paper statistics

Downloads
50
Abstract Views
426
PlumX Metrics