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  5. Monetary Policy without Commitment

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Monetary Policy without Commitment

  • Hassan Afrouzi
  • Marina Halac
  • Kenneth Rogoff
  • Pierre Yared
American Economic Review (Forthcoming)

Abstract

This paper studies the implications of central bank credibility for long-run inflation and inflation dynamics. We introduce central bank lack of commitment into a standard non-linear New Keynesian economy with sticky-price monopolistically competitive firms. Inflation is driven by the interaction of lack of commitment and the economic environment. We show that long-run inflation increases following an unanticipated permanent increase in the labor wedge or decrease in the elasticity of substitution across varieties. In the transition, inflation overshoots and then gradually declines. Quantitatively, inflation overshooting is persistent, and the welfare loss from lack of commitment relative to inflation targeting is large.

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