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In the New Keynesian model, even if the central bank does not have an over-ambitious output target, policy under discretion leads to an inefficiency known as the stabilization bias. In this paper, using a New Keynesian model, we explore and quantify how a cost channel and multi-period data revisions affect the size of the stabilization bias. We find that the presence of a cost channel in the model increases the stabilization bias significantly. On the other hand, multi-period revisions to output and inflation reduce the inefficiency associated with discretionary policy.
Keywords: stabilization bias; discretion; commitment; cost-channel; information lags; data revisions
Published Online: 2010-11-16
©2011 Walter de Gruyter GmbH & Co. KG, Berlin/Boston
