TY  - JOUR
AU  - Athey,Susan
AU  - Atkeson,Andrew
AU  - Kehoe,Patrick
TI  - The Optimal Degree of Discretion in Monetary Policy
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 10109
PY  - 2003
Y2  - November 2003
UR  - http://www.nber.org/papers/w10109
L1  - http://www.nber.org/papers/w10109.pdf
N1  - Author contact info:
Susan Athey
Department of Economics
Harvard University
1875 Cambridge St.
Cambridge, MA 02138
Tel: 650/725-8696
Fax: 650/725-5702
E-Mail: athey@fas.harvard.edu

Andrew Atkeson
Bunche Hall 9381
Department of Economics
UCLA
Box 951477
Los Angeles, CA  90095-1477
Tel: 866/312-9770
Fax: 310/825-9528
E-Mail: andy@atkeson.net

Patrick Kehoe
Research Department
Federal Reserve Bank of Minneapolis
90 Hennepin Avenue
Minneapolis, MN  55480-0291
Tel: 612/204-5525
Fax: 612/204-5515
E-Mail: pkehoe@res.mpls.frb.fed.us
AB  - How much discretion should the monetary authority have in setting its policy? This question is analyzed in an economy with an agreed-upon social welfare function that depends on the randomly fluctuating state of the economy. The monetary authority has private information about that state. In the model, well-designed rules trade off society's desire to give the monetary authority discretion to react to its private information against society's need to guard against the time inconsistency problem arising from the temptation to stimulate the economy with unexpected inflation. Although this dynamic mechanism design problem seems complex, society can implement the optimal policy simply by legislating an inflation cap that specifies the highest allowable inflation rate. The more severe the time inconsistency problem, the more tightly the cap constrains policy and the smaller is the degree of discretion. As this problem becomes sufficiently severe, the optimal degree of discretion is none.
ER  -