Monetary Policy Game and Dynamic Inconsistency

Some policy may not be optimal when implemented, even though it is so at the time of its planning. This possibility is called dynamic inconsistency. It is well known that monetary policy suffered from this because of its flexibility. That is, even though the monetary authority makes the commitment to a given rate of growth of money stock in advance, she can raise it over this commitment level easily without permission at the implementation stage. So the commitment may not be credible. On the other hand, when the monetary policy is implemented with discretion by the policymaker, the rate of inflation is higher than the one in use of the credible precommitment and the unemployment rate of the former is the same as the latter in spite of its higher rate of inflation. Therefore the social welfare deteriorates under the discretionary monetary policy, which results in inefficiency. This situation can be analyzed as the game played between the policymaker and the private sector. Some recent studies on monetary policy deal with this lnefficiency problem and propose several measures to solve it. The aim of this paper is to survey these recent literatures and have some perspective about these measures to reduce such inefficiency