An Investigation of the Gains from Commitment in Monetary Policy

Abstract

This paper proposes a simple framework for analyzing a continuum of monetary policy rules characterized by differing degrees of credibility, in which commitment and discretion become special cases of what we call quasi commitment. The monetary policy authority is assumed to formulate optimal commitment plans, to be tempted to renege on them, and to succumb to this temptation with a constant exogenous probability known to the private sector. By interpreting this probability as a continuous measure of the (lack of) credibility of the monetary policy authority, we investigate the welfare effect of a marginal increase in credibility. Our main finding is that, in a simple model of the monetary transmission mechanism, most of the gains from commitment accrue at relatively low levels of credibility.

Delegation, time inconsistency and sustainable equilibrium

“…One way of formalizing these costs is to consider the implied welfare costs of reappointment. In an interesting contribution to monetary policy under commitment and discretion, Schaumburg and Tambalotti (2007) assume that the central bank can effectively be reappointed with an exogenously determined probability (α). Upon being reappointed the central bank sets a new policy plan, reneging its predecessor promises.…”

The Macroeconomic Effect of External Pressures on Monetary Policy

“…This is done by taking into account several commitment settings, following the recent contributions of Schaumburg and Tambalotti (2007) and our methods developed in Debortoli and Nunes (2006a). In particular, we show how credible institutions are able to partially counteract the bad externalities generated by the possibility that policy objectives may become more liberal.…”

“…The probabilistic model was also addressed in Roberds (1987) and Schaumburg and Tambalotti (2007). We also use features of Debortoli and Nunes (2006b), where we considered disagreement among successive policymakers.…”

“…To do so, we relax the discretion assumption, typical of the political economy literature. Instead, and following the recent contributions of Schaumburg and Tambalotti (2007) and Debortoli and Nunes (2006a), we model the central bank as possessing a loose commitment technology. In this context, in order to lower inflation expectations created by the possibility to adopt liberal policies, a conservative central bank optimally promises to be even more conservative in the future.…”

Monetary exit and fiscal spillovers

“…Let us mention that our monetary leadership concept is compatible with the timeless perspective commitment of Woodford (1999) or quasi-commitment of Schaumburg and Tambalotti (2007). This is because it does not prescribe (a rule for) how actions need to be dynamically changed in response to disturbances, it only restricts the frequency with which the policy stance can be altered.…”