DP3434 Monetary Policy, Expectations and Commitment

Author(s): George W Evans , Seppo Honkapohja

Publication Date: June 2002

Keyword(s): commitment , interest rate setting , adaptive learning , stability determinacy

JEL(s): D84 , E31 , E52

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP3434.asp

Commitment in monetary policy leads to equilibria that are superior to those from optimal discretionary policies. A number of interest rate reaction functions and instrument rules have been proposed to implement or approximate commitment policy. We assess these optimal reaction functions and instrument rules in terms of whether they lead to an RE equilibrium that is both locally determinate and stable under adaptive learning by private agents. A reaction function that appropriately depends explicitly on private expectations performs well on both counts.