Business Intelligence

Loose Commitment In Medium-Scale Macroeconomic Models: Theory And An Application

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Executive Summary

This paper proposes a method and a toolkit for solving optimal policy with imperfect commitment in linear quadratic models. As opposed to the existing literature, the authors' method can be employed in medium- and large-scale models typically used in monetary policy. They apply the method to the Smets and Wouters (2007) model, where they show that imperfect commitment has relevant implications for the interest rate setting, the sources of business cycle fluctuations, and welfare.

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