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Title:Does the time inconsistency problem make flexible exchange rates look worse than you think? PDF Logo
Authors:Armenter, Roc
Bodenstein, Martin
Issue Date:2005
Series/Report no.:Staff Report, Federal Reserve Bank of New York 230
Abstract:Lack of commitment in monetary policy leads to the well known Barro-Gordon inflation bias. In this paper, we argue that two phenomena associated with the time inconsistency problem have been overlooked in the exchange rate debate. We show that, absent commitment, independent monetary policy can also induce expectation traps - that is, welfare-ranked multiple equilibria - and perverse policy responses to real shocks - that is, an equilibrium policy response that is welfare inferior to policy inaction. Both possibilities imply higher macroeconomic volatility under flexible exchange rates than under fixed exchange rates.
Subjects:time inconsistency
independent monetary policy
exchange rate regimes
Document Type:Working Paper
Appears in Collections:Staff Reports, Federal Reserve Bank of New York

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