Essays on Monetary Policy

This thesis consists of two independent chapters on monetary policy.Chapter 1 studies optimal monetary policy under imperfect credibility in a New Keynesian model with staggered price and wage setting. In our imperfect credibility framework, the central bank commits to a policy plan but occasionally reneges on past promises with a given common knowledge probability. We find that the welfare gains from increasing credibility are approximately linear on the initial credibility level. The variance decomposition shows that wage markup shocks are the main driver of economic fluctuations and that these shocks are better contained when credibility is high. We then show that the degree of credibility impacts the effect of wage flexibility on welfare. When credibility is low, monetary policy is less potent and the economy can experience a feedback loop between wage volatility and price volatility. We show, though, that once wage markup shocks are considered, wage flexibility is welfare improving.Chapter 2 examines the effects of higher inflation expectations on households' consumption plans. Higher inflation expectations can boost private consumption if the real interest rate decreases. However, households often report that they dislike high inflation due to the erosion of nominal income, and standard models often abstract from this channel. This chapter uses a dataset with quantitative expectations for both inflation and nominal interest rates, which allow us to determine consumption behavior both during normal times and zero lower bound (ZLB) periods. We find that higher inflation expectations encourage households to bring forward durable goods purchases while discouraging spending on non-durables. We show that these results are consistent with a model in which higher inflation expectations erode a household's permanent income thereby discouraging non-durable consumption, whereas durable consumption increases due to the lower real rate. Moreover, we analyze different counterfactuals and show that nominal wage expectations are central