Monetary Policy when Preferences are Quasi-Hyperbolic

Richard Dennis and Oleg Kirsanov

Working Papers from Business School - Economics, University of Glasgow

Abstract: We study discretionary monetary policy in an economy where economic agents have quasi-hyperbolic discounting. We demonstrate that a benevolent central bank is able to keep inflation under control for a wide range of discount factors. If the central bank, however, does not adopt the household’s time preferences and tries to discourage early-consumption and delayed-saving, then a marginal increase in steady state output is achieved at the cost of a much higher average inflation rate. Indeed, we show that it is desirable from a welfare perspective for the central bank to quasi-hyperbolically discount by more than households do. Welfare is improved because this discount structure emphasizes the current-period cost of price changes and leads to lower average inflation. We contrast our results with those obtained when policy is conducted according to a Taylor-type rule.

Keywords: Quasi-hyperbolic discounting; Monetary policy; Time-consistency (search for similar items in EconPapers)
JEL-codes: C62 C73 E52 E61 (search for similar items in EconPapers)
Date: 2020-02
New Economics Papers: this item is included in nep-mac and nep-mon
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Working Paper: Monetary policy when preferences are quasi-hyperbolic (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:gla:glaewp:2020_05

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