This paper proposes a monetary policy game based on a microfounded general equilibrium model. The approach allows some key features of the policy game (such as the policy maker’s gap between desired and “natural” output) to be related to basic technological and preference parameters. Moreover, it shows how results are affected by the presence of non-atomistic private agents. A main finding which is emphasized here is that, with non-atomistic labor unions, the policy maker’s aversion to inflation may have a permanent effect on employment even if all agents have rational expectations and complete information. The traditional result, whereby equilibrium employment is unrelated to the policy maker’s aversion to inflation, is obtained as a special case when private agents are atomistic. The model is used to re-examine the welfare effects of monetary policy delegation to a “conservative” central bank.
Published in 2003 in: Review of Economic Studies, v. 70, 4, pp. 909-919
