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A Positive Theory of Monetary Policy in a Natural Rate Model

Robert J. Barro and David B. Gordon
Journal of Political Economy
Vol. 91, No. 4 (Aug., 1983), pp. 589-610
Stable URL: http://www.jstor.org/stable/1831069
Page Count: 22
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A Positive Theory of Monetary Policy in a Natural Rate Model
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Abstract

A discretionary policymaker can create surprise inflation, which may reduce employment and raise government revenue. But when people understand the policymaker's objectives, these surprises cannot occur systematically. In equilibrium people form expectations rationally and the policymaker optimizes in each period, subject to the way that people form expectations. Then, we find that (1) the rates of monetary growth and inflation are excessive; (2) these rates depend on the slope of Phillips curve, the natural unemployment rate, and other variables that affect the benefits and costs from inflation; (3) the monetary authority behaves countercyclically; and (4) unemployment is independent of money policy. Outcomes improve if rules commit future policy choices in the appropriate manner. The value of these commitments--which amount to long-term contracts between the government and the private sector--underlies the argument for rules over discretion.

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