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Discretionary Monetary Policy in the Calvo Model (Revised March 2017)

By Willem Van Zandweghe and Alexander L. Wolman
Working Papers
June 2011, No. 11-03R

We study discretionary equilibrium in the Calvo pricing model for a monetary authority that chooses the money supply, producing three main contributions. First, the model delivers a unique private-sector equilibrium for a broad range of parameterizations, in contrast to earlier results for the Taylor pricing model. Second, a generalized Euler equation shows how the monetary authority affects future welfare through its influence on the future state of the economy. Third, we provide exact solutions, including welfare analysis, for the transitional dynamics that occur if the monetary authority loses or gains the ability to commit.