DP2664 Time Consistency When Open Market Operations are the Monetary Policy Instrument: Is There Really a Deflation Bias?

Author(s): Neil Rankin
Publication Date: January 2001
Keyword(s): Inflation Bias, Monetary Policy, Open Market Operations, Optimal Seigniorage, Time Consistency
JEL(s): E52, E61
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2664

We re-examine optimal monetary policy in a dynamic general equilibrium model where open market operations are the only policy instrument. The government optimizes purely over private agents? welfare. We use a money-in-the-utility-function approach with a welfare cost of ?current? inflation. Under commitment, for the most plausible specification time inconsistency takes the form of surprise inflation, if there is high initial government debt. Although ?orthodox?, this result contradicts Nicolini?s related analysis, in which surprise deflation is the main finding. Under discretion, we find that the long-run inflation rate is quite likely to be positive, not negative as in Obstfeld?s related analysis.