Comment on ‘Market discipline and monetary policy’ by Carl Walsh: a reply

Abstract

In their interesting paper, Fabia de Carvalho and Maurício Bugarin alter the informational assumptions I employed in Walsh (2000) and discuss how this change affects the results reported in my paper. The structure of the underlying model I used, and therefore the rationale for the informational assumption, was designed to capture two factors. First, inflation models developed in the new Keynesian literature emphasize the role of expected future inflation and my model was designed to investigate the difference arising from using the forward-looking new Keynesian inflation models rather than the earlier literature's Lucas supply curve. In the new Keynesian approach, the informational assumption parallels the one I made in my paper—in setting prices (or wages) in period t , agents have information about period t variables. As the authors of this comment note, there is a resulting asymmetry in the informational structure, one that correctly captures the difference between the Lucas supply function and the new Keynesian inflation equation. Making the information assumptions the same for both types of wage models would have simply produced a model in which a simple Lucas supply function would be replaced by something more akin to an older-style multi-period wage or price contracting model.