مقدمة في السياسة النقدية

Course 4 - Inconsistency in Monetary Policy

• Introduction
  • Question: What factors lead a central bank to adjust its benchmark interest rates?
  • Why does a central bank sometimes increase its benchmark rate by 50 basis points instead of 25 or 75 basis points?
  • Since the 1980s, economists have focused on incentives in central bank monetary policy.
  • Credibility of monetary policy is crucial along with central banks' commitment to their targets.
  • Without incentives or constraints, central banks might act contradictorily to their stated commitments.
  • Example: A central bank might promise low inflation (0%), but later take actions that increase inflation in order to stimulate the economy.

Monetary Policy Inconsistency

• Definition:
  • Consistent monetary policy: Policy in future (t+1) corresponds to the announced policy in the current time (t).
  • Inconsistent monetary policy: Policy in future (t+1) deviates from the announced policy in the current time (t).
  • This inconsistency reflects the time-inconsistency problem in monetary policy.

Policy of Commitments vs. Discretionary Policies

• Consistent Policies: The central bank commits to following a clear monetary policy rule, for example, maintaining a fixed inflation rate target.
• Discretionary Policies: The central bank can adjust monetary policy as needed, responding to various economic factors.

Inflation Bias

• Definition: A tendency toward higher inflation than the targeted or desired levels.
• Economists believe that discretionary policies are prone to inflation bias. Central banks may have incentives to deviate from their commitments in order to boost short-term economic activity, even if this leads to higher inflation in the long term.

Central Bank Objectives

• Objectives: The central bank aims to optimize a function that balances output and inflation.
• Function Objective: In the Barro-Gordon model, the central bank objective includes a loss function representing a trade-off between output and inflation.

Central Bank Behavior & Inflation Bias

• Central bank behavior impacts the overall inflation rate if it fails to uphold its commitments.
• The timing of events plays a significant role in understanding the process of inflation bias.
• The central bank's actions only occur after the private sector's anticipations and actions.

Output and Inflation

• Output (Y) and inflation (π) are determined following specific events in the order presented.