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LEARNING, COMMITMENT, AND MONETARY POLICY

THE CASE FOR PARTIAL COMMITMENT

Published online by Cambridge University Press:  15 September 2009

George A. Waters
George A. Waters*
Affiliation:
Illinois State University
*
Address correspondence to: George A. Waters, Department of Economics, Campus Box 4200, Illinois State University, Normal, IL 61790-4200, USA; e-mail: gawater@ilstu.edu.
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Abstract

This paper examines a class of interest rate rules that respond to public expectations and to lagged variables and considers varying levels of commitment that correspond to varying degrees of response to lagged output. Under commitment the policymaker adjusts the nominal rate with lagged output to impact public expectations. Within this class of rules, I provide a condition for nonexplosive and determinate solutions. Expectational stability obtains for any nonnegative response to lagged output. Simulation results show that modified commitment is best under least-squares learning. However, in the presence of parameter uncertainty and/or measurement error in the policymaker's data on public expectations, the best policy is one of partial commitment, where the response to lagged output is less than under modified commitment. The case for partial commitment is strengthened if the gain parameter in the learning mechanism is high, which can be interpreted as the use of few lags by public agents in the formation of expectations or as an indication of low credibility of the policymaker. The appointment of a conservative central banker ameliorates these concerns about modified commitment.

Keywords

LearningMonetary PolicyInterest Rate RulesDeterminacyExpectational Stability
Type
Articles
Information
Macroeconomic Dynamics , Volume 13 , Issue 4 , September 2009 , pp. 421 - 449
Copyright
Copyright © Cambridge University Press 2009

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