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Working Paper 95

Comment on Market Discipline and Monetary Policy by Carl Walsh

Maurício S. Bugarin
Fabia A. de Carvalho


This paper aims at correcting flaws in the way expectations are set in a paper by Walsh (2000) in order to assess with precision the impact of complex market rigidities and market expectations in the optimal choices of inflation in a monetary game between society and central bankers. After setting the expectations right, one of the results achieved indicates that the optimal inflation under any type of central banker is higher than that obtained in the original paper, suggesting that the time inconsistency phenomenon plays a more important role in explaining an inflationary bias than originally interpreted by Walsh (2000). However, if society organizes itself towards shorter tenure wage contracts, inflation will be lower. The results obtained for the output gap of the economy also differ from those achieved by Walsh in the sense that a central banker who is highly committed to previously announced inflation targets will have more opportunities to generate output growth above equilibrium rates and still commit. Finally, the stability of the premises regarding the contractual structure of the economy proposed by Walsh is tested under a game theoretic approach. The outcome of the test is that stability can be guaranteed only under strong assumptions and high symmetry in the sectoral distribution of firms. By using a social welfare function in which price surprises in any direction lead to welfare loss, the results indicate that society is better off by choosing longer tenure wage contracts, moving away from shorter tenure ones, at the cost of higher inflation.


Este artigo mostra que os resultados obtidos em Walsh (2000) são sensíveis à hipótese de que contratos salariais distintos são baseados em diferentes conjuntos informacionais, mesmo quando são negociados simultaneamente. Em particular, as expectativas de inflação futura têm muito menos poder de disciplinar um banqueiro central oportunista quando assumem-se conjuntos informacionais homogêneos.