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How important is precommitment for monetary policy?
Economic outcomes in dynamic economies with forward-looking agents depend crucially on whether or not the central bank can precommit, even in the absence of the traditional "inflation bias." This paper quantifies the welfare differential between precommitment and discretionary policy in both a stylized theoretical framework and in estimated data-consistent models. From the precommitment and discretionary solutions we calculate the permanent deviation of inflation from target that in welfare terms is equivalent to moving from discretion to precommitment, the "inflation equivalent." In ...
Simple monetary policy rules and exchange rate uncertainty
We analyze the performance and robustness of some common simple rules for monetary policy in a new-Keynesian open economy model under different assumptions about the determination of the exchange rate. Adding the exchange rate to an optimized Taylor rule gives only slight improvements in terms of the volatility of important variables in the economy. Furthermore, although the rules including the exchange rate (and in particular, the real exchange rate) perform slightly better than the Taylor rule on average, they sometimes lead to very poor outcomes. Thus, the Taylor rule seems more robust to ...