| Abstract |
This paper re-examines the tradeoff between commitment and flexibility in monetary policy, using a New Keynesian model with private information. Consider a situation in which the central bank minimizes the expected loss from inflation and the output gap, but in which it can act only on its imperfect, private signal about the potential output and it cannot commit. Rules limit the central bank’s flexibility but can provide a partial commitment device. Two types of rules are considered: one is optimal history-dependent bounds on the nominal interest rate, and the other is a fully optimal direct mechanism. In a baseline model, despite its simplicity, the former rule is shown to attain a large fraction of welfare gain that can be achieved by the latter. |