Expectation Traps and Monetary Policy
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NBER Working Paper No. 8912
Issued in April 2002
NBER Program(s): EFG ME
Why is it that inflation is persistently high in some periods and persistently low in other periods? We argue that lack of commitment in monetary policy may bear a large part of the blame. We show that, in a standard equilibrium model, absence of commitment leads to multiple equilibria, or expectation traps. In these traps, expectations of high or low inflation lead the public to take defensive actions which then make it optimal for the monetary authority to validate those expectations. We find support in cross-country evidence for key implications of the model.
Published: Albanesi, Stefania, V. V. Chari and Lawrence J. Christiano. "Expectation Traps And Monetary Policy," Review of Economic Studies, 2003, v70(4,Oct), 715-741.
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