Rules, Discretion and Reputation in a Model of Monetary Policy / Robert J. Barro, David B. Gordon.

By:

Barro, Robert J

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w1079.Publication details: Cambridge, Mass. National Bureau of Economic Research 1983.Description: 1 online resource: illustrations (black and white)Subject(s):

E - Macroeconomics and Monetary Economics

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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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Previous	nber w10787 What Does the Public Know about Economic Policy, and How Does It Know It? /	nber w10788 Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries /	nber w10789 Subjective Mortality Risk and Bequests /	nber w1079 Rules, Discretion and Reputation in a Model of Monetary Policy /	nber w10790 Putting the Brakes on Sudden Stops: The Financial Frictions-Moral Hazard Tradeoff of Asset Price Guarantees /	nber w10791 The Rise of the Fourth Estate: How Newspapers Became Informative and Why It Mattered /	nber w10792 Designing Optimal Disability Insurance: A Case for Asset Testing /	Next

February 1983.

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.