TY  - JOUR
AU  - Chari,V. V.
AU  - Christiano,Lawrence J.
AU  - Eichenbaum,Martin
TI  - Expectation Traps and Discretion
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 5541
PY  - 1996
Y2  - April 1996
UR  - http://www.nber.org/papers/w5541
L1  - http://www.nber.org/papers/w5541.pdf
N1  - Author contact info:
Varadarajan V. Chari
Department of Economics
University of Minnesota
1035 Heller Hall
271 - 19th Avenue South
Minneapolis, MN 55455
Tel: 612/626-5171
Fax: (612) 624-0209
E-Mail: varadarajanvchari@gmail.com

Lawrence Christiano
Department of Economics
Northwestern University
2001 Sheridan Road
Evanston, IL 60208
Tel: 847/491-8231
Fax: 847/491-7001
E-Mail: l-christiano@northwestern.edu

Martin S. Eichenbaum
Department of Economics
Northwestern University
2003 Sheridan Road
Evanston, IL  60208
Tel: 847/491-8232
Fax: 847/491-7001
E-Mail: eich@northwestern.edu
AB  - We argue that discretionary monetary policy exposes the economy to welfare-decreasing instability.  It does so by creating the potential for private expectations about the response of monetary policy to exogenous shocks to be self-fulfilling.  Among the many equilibria that are possible, some have good welfare properties.  But others exhibit welfare-decreasing volatility in output and employment. We refer to the latter type of equilibria as expectation traps.  In effect, our paper presents a new argument for commitment in monetary policy because commitment eliminates these bad equilibria.  We show that full commitment is not necessary to achieve the best outcome, and that more limited forms of commitment suffice.
ER  -