Expectation Traps and Monetary Policy

Abstract

We thank three anonymous referees and an editor for useful comments. Chari and Christiano thank the National Science Foundation for support. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research, the Federal reserve Banks of Chicago or Minneapolis or the Federal Reserve System.

Discretionary Policy, Multiple Equilibria, and Monetary Instruments

“…The central bank's plan therefore exhibits a unique solution only if the weight ϕ is sufficiently small. Otherwise, discretionary policy is associated with equilibrium multiplicity, which has also been shown by Brueckner and Schabert (2005) and Kurozumi (2005) for an isomorphic model and by Albanesi et al (2003), King and Wolman (2004), and Siu (2005) for models with different price setting schemes. The condition for the existence of multiple equilibria is summarized in the following lemma.…”

DOES INFLATION TARGETING ANCHOR LONG-RUN INFLATION EXPECTATIONS? EVIDENCE FROM THE U.S., UK, AND SWEDEN4

“…Although we have not shown in this paper that there any advantages, either qualitatively or quantitatively, to the stabilization of long-term inflation expectations, existing macroeconomic and finance theory suggests that there should be several-for example, less persistent deviations of inflation from target in the near term due to firmer anchoring of expectations at the long end, and a greater ability of the central bank to control inflation in the short and medium run (Svensson and Woodford 2003;Orphanides and Williams 2005); less volatile long-term nominal interest rates and lower risk premia on nominal rates that would improve the efficiency of investment decisions (Ingersoll and Ross 1992); and a reduced chance of a 1970s-style "expectations trap" for inflation (Albanesi, Chari, and Christiano 2003) or an imperfect informationdriven "inflation scare" (Orphanides and Williams 2005). To the extent that these benefits are important in practice as well as in principle, there are reasons to think that, with a more explicit inflation objective, U.S. monetary policy and economic performance could be improved even beyond the successes of the past 20 years.…”

Did the great inflation occur despite policymaker commitment to a Taylor rule?

“…Examples include Clarida, Gali, and Gertler (2000), Christiano and Gust (1999), Ireland (1999), and Albanesi, Chari, and Christiano (2002). The studies of Sargent (1999), Cho, Williams, and Sargent (2002), Bullard and Cho (2003), Primaceri (2004), and Williams (2003) emphasize escape dynamics and possession of a misspecified model on the part of policymakers.…”