Gradualism in Monetary Policy: A Time-Consistency Problem?

44 Pages Posted: 21 Sep 2015 Last revised: 9 Jun 2021

See all articles by Jeremy C. Stein

Jeremy C. Stein

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Aditya Sunderam

Harvard University

Date Written: September 2015


We develop a model of monetary policy with two key features: (i) the central bank has private information about its long-run target for the policy rate; and (ii) the central bank is averse to bond-market volatility. In this setting, discretionary monetary policy is gradualist, or inertial, in the sense that the central bank only adjusts the policy rate slowly in response to changes in its privately-observed target. Such gradualism reflects an attempt to not spook the bond market. However, this effort ends up being thwarted in equilibrium, as long-term rates rationally react more to a given move in short rates when the central bank moves more gradually. The same desire to mitigate bond-market volatility can lead the central bank to lower short rates sharply when publicly-observed term premiums rise. In both cases, there is a time-consistency problem, and society would be better off appointing a central banker who cares less about the bond market. We also discuss the implications of our model for forward guidance once the economy is away from the zero lower bound.

Suggested Citation

Stein, Jeremy C. and Sunderam, Aditya, Gradualism in Monetary Policy: A Time-Consistency Problem? (September 2015). NBER Working Paper No. w21569, Available at SSRN:

Jeremy C. Stein (Contact Author)

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Aditya Sunderam

Harvard University ( email )

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