Journal Article

Expectation Traps and Monetary Policy

Stefania Albanesi, V. V. Chari and Lawrence J. Christiano

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 70, issue 4, pages 715-741
Published in print October 2003 | ISSN: 0034-6527
Published online October 2003 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/1467-937X.00264
Expectation Traps and Monetary Policy

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  • Information, Knowledge, and Uncertainy
  • Prices, Business Fluctuations, and Cycles
  • Monetary Policy, Central Banking, and the Supply of Money and Credit

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Why is inflation persistently high in some periods and low in others? The reason may be the absence of commitment in monetary policy. In a standard model, absence of commitment leads to multiple equilibria, or expectation traps, even without trigger strategies. In these traps, expectations of high or low inflation lead the public to take defensive actions, which then make accommodating those expectations the optimal monetary policy. Under commitment, the equilibrium is unique and the inflation rate is low on average. This analysis suggests that institutions which promote commitment can prevent high inflation episodes from recurring.

Keywords: D84; E31; E52

Journal Article.  11836 words.  Illustrated.

Subjects: Information, Knowledge, and Uncertainy ; Prices, Business Fluctuations, and Cycles ; Monetary Policy, Central Banking, and the Supply of Money and Credit

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