Expectation traps and monetary policy
Abstract: Why is it that inflation is persistently high in some periods and persistently low in other periods? We argue that lack of commitment in monetary policy may bear a large part of the blame. We show that, in a standard equilibrium model, absence of commitment leads to multiple equilibria, or expectation traps. In these traps, expectations of high or low inflation lead the public to take defensive actions which then make it optimal for the monetary authority to validate those expectations. We find support in cross-country evidence for key implications of the model.
Keywords: Monetary policy;
File(s): File format is application/pdf http://www.chicagofed.org/digital_assets/publications/working_papers/2002/WP2002-04.pdf
Provider: Federal Reserve Bank of Chicago
Part of Series: Working Paper Series
Publication Date: 2002