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Monetary Policy without Commitment
(Forthcoming Article) - This paper studies the implications of central bank credibility for
long-run inflation and inflation dynamics. We introduce central bank
lack of commitment into a standard non-linear New Keynesian economy
with sticky-price monopolistically competitive firms. Inflation is driven
by the interaction of lack of commitment and the economic environment.
We show that long-run inflation increases following an unanticipated
permanent increase in the labor wedge or decrease in the elasticity
of substitution across varieties. In the transition, inflation overshoots
and then gradually declines. Quantitatively, inflation overshooting is
persistent, and the welfare loss from lack of commitment relative to
inflation targeting is large.
