School of Economics and Finance

No. 442: Time-consistent Monetary Policy Rules

Gerhard Sorger , Queen Mary, University of London

October 1, 2001

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A monetary policy rule is a function mapping any given output level of the economy to a corresponding rate of inflation. Such a rule is time-consistent if the central bank has no incentive to deviate from it. Within a simple dynamic model combining an output-inflation trade-off with rational private-sector expectations we study existence and properties of time-consistent monetary policy rules. It is shown that such rules exist only if (i) the central bank gives relatively high weight to price stability and relatively low weight to output stabilization and if (ii) the random shocks to the economy are not too strong. If time-consistent monetary policy rules exist, they are generically non-unique.

J.E.L classification codes: E61, E52

Keywords:Monetary policy, Time-consistency, Policy rules, Inflation