Limited Commitment, Inaction and Optimal Monetary Policy

This paper examines the optimal frequency of monetary policy meetings when their schedule is pre-announced. Our contribution is twofold. First, we show that in the standard New Keynesian framework infrequent but periodic revision of monetary policy may be desirable even when there are no explicit costs of policy adjustment. Adjustment of policy on a pre-announced schedule de facto acts as a commitment not to adjust in intermediate periods. We find that at short horizons gains from such commitment outweigh welfare costs of central bank's inaction. Second, we solve for the optimal frequency of policy adjustment and characterize its determinants. When applied to the U.S. economy, our analysis suggests that the Federal Open Markets Committee should revise the federal funds target rate no more than twice a year.