Scandinavian Working Papers in Economics
Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)
No 139: How Important Is Precommitment for Monetary Policy?
Richard Dennis () and Ulf Söderström ()
Additional contact information
Richard Dennis: Federal Reserve Bank of San Francisco, Postal: Mail Stop 1130, 101 Market Street, San Francisco, CA 94105, USA
Ulf Söderström: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Abstract: 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 the estimated models, using a range of reasonable central bank preference parameters, the "inflation equivalent" ranges from 0.05 to 3.6 percentage points, with a mid-point of either 0.15 or 1–1.5 percentage points, depending on the model. In addition to the degree of forward-looking behavior, we show that the existence of transmission lags and/or information lags is crucial for determining the welfare gain from precommitment.
Keywords: Optimal monetary policy; stabilization bias; precommitment; discretion
37 pages, September 1, 2002
Full text files
wp_139.pdf
- Fortchoming as
- Richard Dennis and Ulf Söderström, 'How Important Is Precommitment for Monetary Policy?', Journal of Money, Credit, and Banking
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