Quantifying and sustaining welfare gains from monetary commitment

Arbeitspapier

The objectives of this paper are: first, to quantify the stabilization welfare gains from commitment; second, to examine how commitment to an optimal rule can be sustained as an equilibrium and third, to find a simple interest rate rule that closely approximates the optimal commitment one. We utilize an influential empirical micro-founded DSGE model, the euro area model of Smets and Wouters (2003), and a quadratic approximation of the representative household’s utility as the welfare criterion. Importantly, we impose the effect of a nominal interest rate zero lower bound. In contrast with previous studies, we find significant stabilization gains from commitment: our central estimate is a 0.4 - 0.5% equivalent permanent increase in consumption, but in a variant with a higher degree of price stickiness, gains of over 2% are found. We also find that a simple optimized commitment rule with the nominal interest rate responding to current inflation and the real wage closely mimics the optimal rule.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ECB Working Paper ; No. 709

Classification and Topics

• Classification: Wirtschaft ; Monetary Policy ; Prices, Business Fluctuations, and Cycles: Forecasting and Simulation: Models and Applications ; Central Banks and Their Policies
• Subject: commitment ; discretion ; Monetary rules ; welfare gains ; Geldpolitik ; Wohlfahrtsanalyse ; Theorie

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Levine, Paul ; McAdam, Peter ; Pearlman, Joseph G.
• Event: Veröffentlichung
• (who): European Central Bank (ECB)
• (where): Frankfurt a. M.
• (when): 2007

Further information

• Handle: http://hdl.handle.net/10419/153143
• Last update: 10.03.2025, 11:44 AM CET