Monetary Policy when Preferences are Quasi- Hyperbolic

We study discretionary monetary policy in an economy where economic agents have
quasi-hyperbolic discounting. We demonstrate that a benevolent central bank is able to
keep inflation under control for a wide range of discount factors. If the central bank,
however, does not adopt the household’s time preferences and tries to discourage earlyconsumption
and delayed-saving, then a marginal increase in steady state output is
achieved at the cost of a much higher average inflation rate. Indeed, we show that it is
desirable from a welfare perspective for the central bank to quasi-hyperbolically discount
by more than households do. Welfare is improved because this discount structure
emphasizes the current-period cost of price changes and leads to lower average
inflation. We contrast our results with those obtained when policy is conducted according
to a Taylor-type rule.