Working Paper

Sustainable monetary policy and inflation expectations

Abstract: The author shows that the short-term nominal interest rate can anchor private-sector expectations into low inflation more precisely, into the best equilibrium reputation can sustain. He introduces nominal asset markets in an infinite horizon version of the Barro-Gordon model. The author then analyzes the subset of sustainable policies compatible with any given asset price system at date t = 0. While there are usually many sustainable inflation paths associated with a given set of asset prices, the best sustainable inflation path is implemented if and only if the short-term nominal bond is priced at a certain discount rate. His results suggest that policy frameworks must also be evaluated on their ability to coordinate expectations.

Keywords: Inflation (Finance); Interest rates; Asset pricing;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2010

Number: 10-20