Barro-Gordon Revisited: Reputational Equilibria in a New Keynesian Model

The aim of this paper is to solve the inconsistency problem à la Barro/Gordon within a New Keynesian model and to derive time-consistent interest rate rules of Taylor-type. We find a multiplicity of time-consistent rules. In contrast to the famous Kydland/Prescott-Barro/Gordon approach, implementing a monetary rule where the cost and benefit resulting from inconsistent policy coincide – which implies a net gain of inconsistent policy behavior equal to zero – is not optimal. Instead, the solution can be improved by moving into the time-consistent area where the net gain of inconsistent policy is negative. When additionally considering a cost-push shock, the area of time-consistent simple rules of Taylor type becomes graphically smaller. Finally, we find that numerous estimated Taylor rules are time-inconsistent since the empirically observed coefficient on inflation is too low.