Timeconsistency can explain why politicians who realize this still succumb to the shortrun temptation to inflate in a vain attempt to induce such an. Related literature three prior experiments have been conducted that are related to this paper. This note outlines the barrogordon model of timeconsistent monetary policy, dis. I also present a gametheoretic outline of what is going on in the model which may help some of you to understand the material. The barrogordon model shows how the ability of government to manipulate leads to inflationary bias. Kydlandprescott barro gordon model this paper explores the relationship between the kydlandprescott barro gordon model and models with asymmetric policy preferences. This note outlines the barro gordon model of timeconsistent monetary policy, dis. Inflation and uncertainty at short and long horizons. Show the game including the strategies and the outcomes. Similarly, barro and gordon 1983 argue that discretionary policies tend to inefficiently raise inflation to higher levels than monetary regimes. The model is set up for convenience in discrete time.
Sections 6 and 7 consider the issues of central bank independence. In recent years quantum versions of classical games have. The model is interesting because it illustrates in the simplest possible way the relationship between private sector expectations and the functioning of monetary policy. A reputation strategic model of monetary policy in. Pdf does the barrogordon model explain the behavior of. A positive theory of monetary policy in a natural rate model robert. Warburg professor of economics at harvard university. Interest rate rules, barrogordon model free download as powerpoint presentation. Optimality, rational expectations and time inconsistency applied to. Robert joseph barro born september 28, 1944 is an american macroeconomist and the paul m. I then analyze the subset of sustainable policies compatible with any given asset price system at date t 0. Pdf a positive theory of monetary policy in a nature rate model. While the basic model of time inconsistency, put forward by barro and gordon barro, r.
They use the barro gordon model of timeconsistent policy, in which the output effects of monetary surprises tempt the federal reserve into creating positive trend inflation. This paper explores the relationship between the kydlandprescott barro gordon model and models with asymmetric policy preferences. Request pdf recession aversion, output and the kydlandprescott barrogordon model this paper explores the relationship between the kydlandprescott barrogordon model and models with. Finally, as a robustness check and a further nod to reality, we also consider whether committees of central bankers outperform solo central bankers in the discretionary regime. The problem will get timeinconsistent together with rational objectives and a multiperiod model. Kydlandprescott and barro gordon models can be embedded into a standard general equilibrium model.
The government decides whether to keep the exchange rate fixed or not. The role of government would therefore be limited to. Optimality, rational expectations and time inconsistency. Mcmahon university of warwick july 29, 2014 this note outlines the barro gordon model of timeconsistent monetary policy, discussing the meaning of the equations and how to solve the model. However, relaxing this assumption in the linearquadratic framework of barro and gordon means that the inflation bias is zero and the model cannot explain. Northholland rules, discretion and reputation in a.
Monetary policy situation looks like situation in laffer curve, with no. Section 3 tests the longrun dynamics of the baseline model. The barrogordon model detailed derivation nicola viegi university of pretoria 2012 this note gives a stepbystep derivation of the barro gordon model. Interest rate rules, barrogordon model central banks. I introduce nominal asset markets in an in nite horizon version of the barro gordon model. Rules, discretion and reputation in a model of monetary policy.
Journal of political economy, 91, 589610 is widely accepted now, several authors have expressed serious doubts about the empirical relevance of the model in explaining inflation. A reinterpretation of the gordon and barro model in terms of. But, although these inflation surprises can have some benefits, they cannot arise systematically in equilibrium when people understand the policymakers incentives and form their expectations accordingly. Jan 01, 1983 journal of monetary economics 12 1983 101121. Cahier 200207 does the barrogordon model explain the. Raredisaster model and previous results we use a familiar setup based on raremacroeconomic disasters, as developed in rietz 1988 and barro 2006, 2009. Gordon, rules, discretion and reputation in monetnry pjiry 103 unanticipated monetary expansions, reflected in positive values for ii, 71 lead to increases in real economic activity. Pdf rules, discretion and reputation in a model of monetary. The presentation of the model is divided into three sections. Barro gordon model for avoiding the inflation bias and stabilizing the economy in an efficient way, 1. To that end, it constructs a general gametheoretical model with asymmetric preferences. While there are usually many sustainable ination paths associated with a given set of asset prices, the best sustainable in ation. Recently, cukierman and lippi 1999 have proposed a model in which a second channel for nonneutrality appears, analogous to the effect of. Y14617, usa in a discretionary regime the monetary authority can print morn money and create more inflation than people expect.
It also holds unambiguously for output if the production function is cobbdouglas. Some useful suggestions were provided on earlier drafts by ken arrow, gary becker, bob brito, ben eden, bob hall, bob lucas. In a discretionary regime the monetary authority can print more money and create more inflation than people expect. A positive theory of monetary policy in a natural rate model. There is no mechanism in the model for the policymakers to generate credibility about the announcement of. Specifically, this work is based on a paper by robert barro and david gordon 1983 which models the behavior of a closed economy, with a consolidated public sector, and a private nonfinancial sector, which takes portfolio decisions considering inflationary expectations. Does the timeconsistency problem explain the behavior of. Section 2 presents the modified barro gordon model proposed by ireland 1999. Some inflation may therefore reflect policy preferences. One first inflationary cost to be analyzed is the difference between the present inflation rate r i p and the optimal inflation rate r i. Central bank reputation, cheap talk and transparency as.
Rare disaster probability and options pricing robert j. Section 4 describes our experimental design and hypotheses and section 5 reports on the main findings from our experiment. I extend these models to include tax financed government services that affect production or utility. This paper uses the initial barrogordon concepts of inflationary social costs and. Barro university of chicago, chicago, il 60637, usa nber, cambridge, ma 018, usa david b. Dynamic inconsistency kydland and prescott 1977 barro gordon 1983. The government would be able to cheat agents and force unemployment below its natural level but would not wish to do so. Recession aversion, output and the kydlandprescott barro. While both yield an inflation bias, recession aversion dampens the output effects of contractionary supply shocks. Barro and gordons article 1983 poses a rational expectations and natural rate of unemployment model allegedly consistent with us. Expectation traps and monetary policy stefania albanesi, v. A reinterpretation of the gordon and barro model in terms. In this model, it is assumed that a nation will attempt to keep the unemployment rate below its natural level. To what extent is there a disconnect between theoretical models of monetary policy, and how monetary policy is conducted in the real world.
Barro gordon model how to avoid the inflation bias. Does the barrogordon model explain the behavior of us. Kpbg model explains observed change in relation between in. In this model, it is assumed that a nation will attempt to. On the political economy of monetary policy international. The second presents the basic game played between unions and the monetary. The barro gordon model showed how the ability of government to manipulate output would lead to inflationary bias. A positive theory of monetary policy in a naturalrate model nber.
Christianoliver ewald, johannes geisslery january 28, 2010 abstract we study a game theoretic model of the con ict which arises between a monetary authority and the private sector with regard to the in ationrate. This will create an inflation in wages above their natural level, which ultimately results in an overall rate of inflation that is higher than the natural rate of. Gordon within a new keynesian model and to derive timeconsistent stable. Scribd is the worlds largest social reading and publishing site. Backus and drill 1983 extended the work of barro and gordon to a situation in which the public is uncertain about the preferences of the government. This paper tests the predictions of the barro gordon model using us data on inflation and unemployment. The model is interesting because it illustrates in the simplest possible way the relationship. Does the barrogordon model explain the behavior of us inflation. Does the barro gordon model explain the behavior of us inflation. A reinterpretation of the gordon and barro model in terms of financial stability danilo lopomo beteto wegner. Finance and economics discussion series divisions of. Note that in this model the only credible policy is the consistent one. Game theory has widespread application in economic, social and biological sciences.
Interestingly enough, few attempts have been made so far to test for the existence of. Barro is considered one of the founders of new classical macroeconomics, along with robert lucas, jr. Barro and gordon s 1983 celebrated model of timeconsistent monetary policy o. Some inflation may, therefore, reflect policy preferences. Economic growth in a cross section of countries robert j. The main innovation of the barro gordon analysis is to go beyond this. Inflation and monetary policy in the twentieth century federal. Likelihood ratio tests indicate that the restriction imposed by the barro gordon model is rejected by the data but the one imposed by the version of cukiermans model is not. Rules, discretion and reputation in a model of monetary. Government spending in a simple model of endogeneous growth. Barro and gordon 22 have explained time inconsistency of monetary policy as follow. In barro and gordon s model, a policymaker desires to reduce unemployment and, lacking the ability to commit in advance to amonetary policy rule, is tempted todo so in eachperiodbycreating. Does the barrogordon model explain the behaviour of.
A quarter of a century after kydlands and prescotts pioneer work kydland and prescott, 1977 game. Pdf rules, discretion and reputation in a model of. The attractions of generating revenue from surprise inflation are clear if we. Does the timeconsistency problem explain the behavior of in. Section 3 presents a two party version of this model, which is tested in section 4. Testing the barro gordon model in breaking and dependent panels.
Basher, david edgerton october 12, 2005 abstract the barro gordon model of monetary policy implies that inflation will inherit the persistency of the natural rate of unemployment when the central bank cannot commit to a monetary policy rule. Government spending in a simple model of endogenous growth robert j. Barro harvard university and national bureau of economic research one strand of endogenousgrowth models assumes constant returns to a broad concept of capital. The incentive for policymakers to create surprise inflation is shown below. Section 5 discusses recent models of rational political business cycles. This paper is based on his application of the modified bg model.
Barro and gordon 1983a modify the social objective function, making both the deviations of inflation and unemployment from target quadratic terms, whereas the implied model in kydland and prescott 1977 enters the deviation of unemployment from target as a linear, and not quadratic, term. Naturalrate models suggest that the systematic parts of monetary policy will not. Stochastic reaction strategies in the barrogordon framework. Setup of the model as in previous models barro and gordon 1983a, b, costs for period t depend on actual and unexpected inflation, where v is actual inflation for period t and 7r, is the representative persons forecast of.
The level of output is determined by an expectationsaugmented phillips curve. The main criticism to this literature addresses the lack of microeconomic underpinnings for the. Robert joseph barro born september 28, 1944 is an american classical macroeconomist and the paul m. Stochastic reaction strategies in the barro gordon framework. University of queensland august 12, 2014 abstract a government bailout model based on the framework of timeconsistent monetary policy of barro and gordon 1983 is developed. They callout for a more detailedanalysis that uses the barro gordon model as a basis for statistical tests of the hypothesis that the timeconsistency. The barro gordon model shows how the ability of government to manipulate leads to inflationary bias. In contrast to the famous kydlandprescott barro gordon approach, implementing a monetary rule where the cost and benefit resulting from inconsistent policy coincide.
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