Quantifying and sustaining welfare gains from monetary commitment

Our objectives are: to quantify the stabilization welfare gains from commitment; to examine how commitment to an optimal rule can be sustained as an equilibrium: to find a simple interest rate rule that approximates the optimal commitment one. We utilize an empirical micro-founded euro-area DSGE model, a quadratic approximation of household utility as the welfare criterion, employing a nominal interest rate lower bound. In contrast to previous studies, we find significant commitment stabilization gains of around a 0.4-0.5% equivalent permanent consumption increase, and with higher price stickiness gains over 2%. We find that a simple optimized commitment rule responding to inflation and the real wage mimics the optimal one. (C) 2008 Elsevier B.V. All rights reserved.