Abstract
This paper identifies a new coordination motive endogenously induced by a central bank’s lack of commitment in the presence of information imperfection. We show that when differentially informed economic agents disagree about the central bank’s inflation incentives, discretion in monetary policymaking induces agents to coordinate by “forecasting the forecasts of others” in order to forecast the central bank’s policy actions. In particular, the induced coordination mechanism compels the central bank to choose monetary policy that responds to fluctuations in the average belief about its incentive. As a result, discretion has the potential to vastly increase fluctuations in employment and inflation, especially when the disagreement among agents is low. More broadly, our paper makes an argument for the inclusion of information diversity among agents in monetary policy discussions and in the characterization of the inflation dynamics.
Authors
- Marvin Goodfriend
- Pierre Jinghong Liang
- Gaoqing Zhang
JEL codes
- E52
- E61
- D82