Monetary Discretion, Pricing Complementarity and Dynamic Multiple Equilibria

choose to raise prices by a large amount because they (rationally) believe that others are
raising prices, the result is a reduction in real aggregate demand and a decline in output
relative to the level that would prevail if smaller price adjustments took place. Economic
volatility then, as well as high inflation, may be a cost of discretion in monetary policy.

The mechanism leading to complementarity and multiple equilibria here transcends
our example of monetary policy in a staggered pricing model. Other environments which
share two features have the potential to generate similar results. First, private agents
must be forward-looking and their actions must be influenced by their expectations about
future policy. Second, private agents’ actions must determine a state variable to which
future policy responds. These features seem quite widespread, suggesting that lack of
commitment may be an important cause of economic instability.

extension would allow us to take the model more seriously as a potential explanation for some of the
volatility observed in actual macroeconomic time series.

33

<<   32   33   34   35   36   37   38   >>

More intriguing information