Gains from commitment policy for a small open economy: The case of New Zealand

Author name: 
Liu P

The importance of the time-consistency problem depends critically on the model one is working with and its parameterizations. This paper attempts to quantify the magnitude of stabilization bias for a small open economy using an empirically estimated micro-founded dynamic stochastic general equilibrium model. The resultant model is used to investigate the degree to which precommitment policy can improve welfare. Rather than presenting a point estimate of the welfare gain measures, the paper maps out the entire distribution of the welfare gain using the Bayesian posterior distribution of the model’s parameters. The welfare improvement is an increasing function of the weight the central bank place on exchange rate variability. However, there is no simple relationship between the gains from precommitment and the degree of openness of the economy.

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