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How Much Better Is Commitment Policy Than Discretionary Policy? Evidence From Six Developed Economies

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  • Scott C. Patrick

    (Department of Economics and Finance, College of Business, Louisiana Tech University, PO Box 10318, Ruston, LA, 71272, USA)

Abstract

Much has been written on how an active central bank produces inflation outcomes above and beyond what commitment policy would produce. This paper contributes to this body of literature by simulating from the state estimates of both commitment and discretionary policy equilibria in a familiar dynamic New–Keynesian framework. Optimal interest rate and inflation rate policies are derived under the two regimes for six developed economies. The model is estimated using Bayesian methods employing a random-walk Metropolis–Hastings algorithm. Optimal inflation and interest rate policies for each of the economies are simulated. Results suggest that the simulated inflation induced by discretionary policy is not significantly different from commitment policy after 2000 for five of the six countries (including the U.S). Simulated commitment interest rate policy is on average 1.9% higher at the center of the distribution, suggesting that discretionary interest rate policy is on average more often loose compared to commitment interest rate policy. Simulations of the average inflation deviation and welfare loss of discretion policy indicate are greatest when the central bank exhibits low preference for inflation targeting and high preference for output stability.

Suggested Citation

  • Scott C. Patrick, 2020. "How Much Better Is Commitment Policy Than Discretionary Policy? Evidence From Six Developed Economies," The B.E. Journal of Macroeconomics, De Gruyter, vol. 20(2), pages 1-28, June.
    • Handle: RePEc:bpj:bejmac:v:20:y:2020:i:2:p:28:n:8
    DOI: 10.1515/bejm-2019-0170
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    More about this item

    Keywords

    optimal monetary policy; timeless perspective policy; discretionary policy; monetary policy deviations; Bayesian inference;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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