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The reputational constraint on monetary policy

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Author Info
John Whittaker
Abstract

In the context of a standard model of optimal monetary policy, I argue that expectations should be treated as adaptive rather than rational. This argument is justified by considering the rational expectations equilibrium of this model as the limit point of a sequence in which agents progressively modify their forecasts of inflation to make them efficient. I show that this learning process is unlikely to occur, in real time, because of the large amount of data that would be required. When expectations are adaptive, there is no longer a time-inconsistency problem, and since inflation policy influences expectations of future inflation, the central bank s concern for its reputation induces it to deliver optimal (time-consistent) policy. In a final section, the implications of these results for central bank independence are discussed.

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Paper provided by Lancaster University Management School, Economics Department in its series Working Papers with number 000038.

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Date of creation: 2001
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Handle: RePEc:lan:wpaper:000038

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  1. Persson, Torsten & Tabellini, Guido, 1999. "Political economics and macroeconomic policy," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 22, pages 1397-1482 Elsevier. [Downloadable!] (restricted)
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  2. J. E. King, 1999. "Introduction," Review of Political Economy, Taylor and Francis Journals, vol. 11(3), pages 251-255, July. [Downloadable!] (restricted)
  3. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121. [Downloadable!] (restricted)
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  4. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
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  5. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings, Federal Reserve Bank of Kansas City, pages 277-316. [Downloadable!]
  6. McCallum, Bennett T., 1997. "Crucial issues concerning central bank independence," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 99-112, June. [Downloadable!] (restricted)
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  7. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  8. Forder, James, 2000. "Central Bank Independence and Credibility: Is There a Shred of Evidence?: Review," International Finance, Blackwell Publishing, vol. 3(1), pages 167-85, April. [Downloadable!] (restricted)
  9. Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September. [Downloadable!] (restricted)
  10. Goodhart, Charles A E & Huang, Haizhou, 1998. "Time Inconsistency in a Model with Lags, Persistence, and Overlapping Wage Contracts," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 378-96, July.
  11. Svensson, Lars E O, 1999. "Price-Level Targeting versus Inflation Targeting: A Free Lunch?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 277-95, August.
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  12. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608.
  13. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December. [Downloadable!] (restricted)
  14. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June. [Downloadable!] (restricted)
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  15. J. Schuster, 1999. "Introduction," Journal of Cultural Economics, Springer, vol. 23(1), pages 1-2, March. [Downloadable!] (restricted)
  16. Alesina, Alberto & Summers, Lawrence H, 1993. "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 151-62, May. [Downloadable!] (restricted)
  17. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September. [Downloadable!] (restricted)
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  18. Evans, George W. & Honkapohja, Seppo, 1999. "Learning dynamics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542 Elsevier. [Downloadable!] (restricted)
  19. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June. [Downloadable!] (restricted)
  20. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier. [Downloadable!] (restricted)
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