Working Paper: NBER ID: w1079
Authors: Robert J. Barro; David B. Gordon
Abstract: In a discretionary regime the monetary authority can print more money and create more inflation than people expect. But, although these inflation surprises can have some benefits, they cannot arise systematically in equilibrium when people understand the policymaker's incentives and form their expectations accordingly. Because the policymaker has the power to create inflation shocks ex post, the equilibrium growth rates of money and prices turn out to be higher than otherwise. Therefore, enforced commitments (rules) for monetary behavior can improve matters. Given the repeated interaction between the policymaker and the private agents, it is possible that reputational forces can substitute for formal rules.Here, we develop an example of a reputational equilibrium where the out-comes turn out to be weighted averages of those from discretion and those from the ideal rule. In particular, the rates of inflation and monetary growth look more like those under discretion when the discount rate is high.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Discretionary regime (H61) | Inflation surprises (E31) |
| Inflation surprises (E31) | Higher equilibrium growth rates of money and prices (E49) |
| Discretionary regime (H61) | Higher equilibrium growth rates of money and prices (E49) |
| Enforced commitments to monetary rules (F33) | Lower inflation (E31) |
| Enforced commitments to monetary rules (F33) | Lower monetary growth (E49) |
| Reputational forces (L14) | Sustaining monetary rules (E61) |
| Sustaining monetary rules (E61) | Better long-term outcomes (D15) |
| Public understanding of policymaker's incentives (D72) | Systematic inflation surprises (E31) |