Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/153143
Authors: 
Levine, Paul
McAdam, Peter
Pearlman, Joseph G.
Year of Publication: 
2007
Series/Report no.: 
ECB Working Paper 709
Abstract: 
The objectives of this paper are: first, to quantify the stabilization welfare gains from commitment; second, to examine how commitment to an optimal rule can be sustained as an equilibrium and third, to find a simple interest rate rule that closely approximates the optimal commitment one. We utilize an influential empirical micro-founded DSGE model, the euro area model of Smets and Wouters (2003), and a quadratic approximation of the representative household’s utility as the welfare criterion. Importantly, we impose the effect of a nominal interest rate zero lower bound. In contrast with previous studies, we find significant stabilization gains from commitment: our central estimate is a 0.4 - 0.5% equivalent permanent increase in consumption, but in a variant with a higher degree of price stickiness, gains of over 2% are found. We also find that a simple optimized commitment rule with the nominal interest rate responding to current inflation and the real wage closely mimics the optimal rule.
Subjects: 
commitment
discretion
Monetary rules
welfare gains
JEL: 
E52
E37
E58
Document Type: 
Working Paper

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