Working Paper: CEPR ID: DP3434
Authors: George W. Evans; Seppo Honkapohja
Abstract: Commitment in monetary policy leads to equilibria that are superior to those from optimal discretionary policies. A number of interest rate reaction functions and instrument rules have been proposed to implement or approximate commitment policy. We assess these optimal reaction functions and instrument rules in terms of whether they lead to an RE equilibrium that is both locally determinate and stable under adaptive learning by private agents. A reaction function that appropriately depends explicitly on private expectations performs well on both counts.
Keywords: Adaptive Learning; Commitment; Interest Rate Setting; Stability; Determinacy
JEL Codes: D84; E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| commitment in monetary policy (E52) | superior equilibria than optimal discretionary policies (E61) |
| reaction function incorporating private expectations (D84) | rational expectations equilibrium that is locally determinate and stable (C62) |
| optimal reaction functions and instrument rules (C36) | improved stability and determinacy in monetary policy outcomes (E63) |
| design of reaction functions (D79) | performance contingent on alignment with private agents' expectations (D82) |