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Discussion Paper Details

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Title: Discretionary Policy, Multiple Equilibria, and Monetary Instruments

Author(s): Andreas Schabert

Publication Date: December 2005

Keyword(s): equilibrium indeterminacy, history dependence, Monetary policy implementation, money growth policy and optimal discretionary policy

Programme Area(s): International Macroeconomics

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.

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Bibliographic Reference

Schabert, A. 2005. 'Discretionary Policy, Multiple Equilibria, and Monetary Instruments'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=5400