CAN THE U.S. MONETARY POLICY FALL (AGAIN) IN AN EXPECTATION TRAP?

Abstract

We propose a model to study monetary policy under discretion. We focus on Markov perfect equilibria, ruling out trigger strategies. The model is simple enough that the determinants of monetary policy under discretion are clear. We also find that for all parameterizations with an equilibrium inflation rate around 2%, there is a second equilibrium with an inflation rate just above 10%. Thus the model can simultaneously account for the low- and high-inflation episodes in the U.S. experience.