Monetary Discretion, Pricing Complementarity and Dynamic Multiple Equilibria



in each period. At the same time, the structure of the model they study is quite different
from ours. The stimulative policies that produce inflation in their model also raise nominal
interest rates and lead to money demand distortions, either by driving a relative price
wedge between the cost of buying goods on cash and credit or by increasing transactions
time. A monetary authority thus faces a trade-off between the benefits of driving down
the markup and these costs. In our model, instead of the costs of realized inflation being
related to money demand, they involve price distortions across goods whose prices were
set in different periods.13

If there are sunspots which switch the economy between equilibria, there are also
important differences in the consequences that are suggested by our model from those
suggested by the ACC models. In our setting, if a high inflation equilibrium occurs when
agents attach low probability to such an event, then there will be a decline in output
because aggregate demand will fall and the average markup will increase. By contrast,
in the ACC models, a switch from low inflation to high inflation will have little effect
on the average markup or output, with the main difference being the extent of money
demand distortions. Since the ACC models are essentially static ones, there is also another
difference: there is no feedback between the likelihood that economic agents attach to
future equilibria and the levels of inflation and output at a point in time. Accordingly
beliefs about the future are of no bearing for current events. In our model, beliefs about
future outcomes affect the nature of the current policy problem because firms setting their
price in the current period care about both current and future monetary policy.

7 Discretion and Multiplicity more Generally

Multiple equilibria arise under discretion in our model because of policy-induced com-
plementarity among private agents. The complementarity involves interaction between
forward-looking firms and a future policymaker who will respond to the state variable
determined by those firms. We will argue here that similar types of complementarity
are present more generally when policy is formulated without commitment. For general-
izations of our staggered pricing model we know this to be true, and thus we speculate
on some empirical implications of monetary discretion. We then describe some other

13 Dedola (2000) studies discretionary policy in a Rotemberg-style model of pricing, and finds multiple
equilibria. Dedola models money demand using a cash-in-advance constraint, and like Albanesi, Chari
and Christiano, the multiple equilibria are related to the money demand specification.

29



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