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A General Theory (and Some Evidence) of Expectation Traps in Monetary Policy
Author(s) -
ARMENTER ROC
Publication year - 2008
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/j.1538-4616.2008.00140.x
Subject(s) - economics , monetary policy , inflation (cosmology) , general equilibrium theory , discretion , markov perfect equilibrium , welfare , keynesian economics , markov chain , mathematical economics , monetary economics , bounded function , property (philosophy) , macroeconomics , nash equilibrium , mathematics , physics , philosophy , epistemology , theoretical physics , political science , law , mathematical analysis , market economy , statistics
I show that multiple equilibria are a general property of economies under full monetary policy discretion. Three simple conditions are sufficient to rule out, generically, a unique equilibrium in a static economy. The key departure from Barro and Gordon (1983) is to consider bounded welfare costs of inflation. I also show that in a two Markov equilibrium economy the inflation response to certain perturbations is, generically, qualitatively different in each equilibrium. Finally, I discuss some evidence on inflation dynamics that supports the hypothesis that U.S. monetary policy was caught in an expectation trap during the high inflation episode of the 1970s.