FRB: Loose Commitment in Medium-Scale Macroeconomic Models: Theory and Applications

International Finance Discussion Papers

Loose Commitment in Medium-Scale Macroeconomic Models: Theory and Applications
Davide Debortoli, Junior Maih, and Ricardo Nunes
2011-1034 (November 2011)

Abstract: This paper proposes a method and a toolkit for solving optimal policy with imperfect commitment. As opposed to the existing literature, our method can be employed in medium- and large-scale models typically used in monetary policy. We apply our method to the Smets and Wouters (2007) model, where we show that imperfect commitment has relevant implications for interest rate setting, the sources of business cycle fluctuations, and welfare.

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Keywords
Commitment, discretion, monetary policy

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