DP3434 Monetary Policy, Expectations and Commitment

Author(s): George W. Evans, Seppo Honkapohja
Publication Date: June 2002
Keyword(s): adaptive learning, commitment, interest rate setting, stability determinacy
JEL(s): D84, E31, E52
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3434

Commitment in monetary policy leads to equilibria that are superior to those from optimal discretionary policies. A number of interest rate reaction functions and instrument rules have been proposed to implement or approximate commitment policy. We assess these optimal reaction functions and instrument rules in terms of whether they lead to an RE equilibrium that is both locally determinate and stable under adaptive learning by private agents. A reaction function that appropriately depends explicitly on private expectations performs well on both counts.