Working Paper: CEPR ID: DP5400
Authors: Andreas Schabert
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: equilibrium; indeterminacy; history dependence; monetary policy implementation; money growth policy; optimal discretionary policy
JEL Codes: E32; E51; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy implementation (E52) | household welfare (I38) |
| history-dependent policies (N40) | household welfare (I38) |
| transactions frictions (L14) | equilibrium multiplicity (C62) |
| discretionary monetary policy (E60) | suboptimal outcomes (I14) |
| inertial interest rate adjustments (E43) | stable history-dependent equilibrium sequences (C62) |
| money growth policies (O42) | stable solutions (C62) |
| transactions frictions (L14) | likelihood of multiple equilibria (C62) |
| central bank's monetary policy reaction functions (E52) | equilibrium indeterminacy (D59) |