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Welfare Gains from Monetary Commitment in a Model of the Euro-Area

Author

Listed:
  • Paul Levine

    (University of Surrey)

  • Peter McAdam

    (European Central Bank)

  • Joseph Pearlman

    (London Metropolitan University)

Abstract

This paper sets out first, to quantify the stabilization gains from commitment in terms of household welfare and second, to examine how commitment to an optimal or approximately optimal rule can be sustained as an equilibrium in which reneging hardly ever occurs. We utilize an influential empirical micro-founded DSGE model, the Euro-Area model of \cite{SW03}, and a quadratic approximation of the epresentative household's utility as the welfare criterion. We impose the effect of a lower zero nominal interest rate bound. In contrast with previous studies we find substantial stabilization gains from commitment -- as much as a $5-6\%$ permanent increase in consumption. We also find that a simple optimized commitment rule with the nominal interest rate responding to current inflation and the real wage closely mimics the optimal rule

Suggested Citation

  • Paul Levine & Peter McAdam & Joseph Pearlman, 2006. "Welfare Gains from Monetary Commitment in a Model of the Euro-Area," Computing in Economics and Finance 2006 403, Society for Computational Economics.
    • Handle: RePEc:sce:scecfa:403
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    More about this item

    Keywords

    Monetary rules; commitment; discretion; welfare gains;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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