Abstract
Since Kydland and Prescott (1977) and Barro and Gordon (1983), most studies of the problem of the inflation bias associated with discretionary monetary policy have assumed a quadratic loss function. We depart from the conventional linear-quadratic approach in favor of a projection method approach. We investigate the size of the inflation bias that arises in a microfounded nonlinear environment with Calvo price setting. The inflation bias is found to lie between 1% and 6% for a reasonable range of parameter values, when the bias is defined as the steady-state deviation of the discretionary inflation rate from the optimal inflation rate under commitment.
Original language | English |
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Pages (from-to) | 1572-1581 |
Number of pages | 10 |
Journal | Journal of Economic Dynamics and Control |
Volume | 34 |
Issue number | 9 |
DOIs | |
Publication status | Published - 2010 Oct |
Externally published | Yes |
Keywords
- Discretionary monetary policy
- Inflation bias
- Projection methods
ASJC Scopus subject areas
- Economics and Econometrics
- Control and Optimization
- Applied Mathematics