Discretion Rather than Rules: Equilibrium Uniqueness and Forward Guidance with Inconsistent Optimal Plans

29 Pages Posted: 10 Dec 2018 Last revised: 29 Apr 2020

See all articles by Jeffrey R. Campbell

Jeffrey R. Campbell

University of Notre Dame; Tilburg University

Jacob Weber

University of California, Berkeley - Department of Economics

Date Written: 2018-09-07

Abstract

New Keynesian economies with active interest rate rules gain equilibrium determinacy from the central bank’s incredible off-equilibrium-path promises (Cochrane, 2011). We suppose instead that the central bank sets interest rate paths and occasionally has the discretion to change them. Private agents taking future central bank actions and their own best responses to them as given reduces the scope for self-fulfilling prophecies. With empirically-reasonable frequencies of central-bank reoptimization, the monetary-policy game has a unique Markov-perfect equilibrium wherein forward guidance influences current outcomes without displaying a forward-guidance puzzle.

Keywords: Keynesian economics, Markov processes, Money policy, Open Market Operations

JEL Classification: E12, E52

Suggested Citation

Campbell, Jeffrey R. and Weber, Jacob, Discretion Rather than Rules: Equilibrium Uniqueness and Forward Guidance with Inconsistent Optimal Plans (2018-09-07). FRB of Chicago Working Paper No. WP-2018-14, Available at SSRN: https://ssrn.com/abstract=3298004 or http://dx.doi.org/10.21033/wp-2018-14

Jeffrey R. Campbell (Contact Author)

University of Notre Dame ( email )

United States

Tilburg University ( email )

Tilburg, 5000 LE
Netherlands

Jacob Weber

University of California, Berkeley - Department of Economics ( email )

Berkeley, CA
United States

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