“Discretionary Monetary Policy, Inflation Bias, and the Zero-Lower Bound” by Richard Dennis
University of Glasgow
We study a sticky price New Keynesian business cycle model in which the central bank conducts monetary policy in order to maximize the welfare of the representative household while lacking the ability to commit. With monetary policy conducted under discretion, we compute a Markov-perfect Nash equilibrium of a model in which the central bank acts as a Stackelberg leader. Using our model as a laboratory, we investigate the model's implications for the business cycle and asset prices, and explore the magnitude of the discretionary inflation bias. We find that the discretionary inflation bias is large for standard parameterizations of the model and that this bias effectively prevents the zero lower bound on the nominal interest rate from binding.