Monetary Policy When Preferences Are Quasi‐Hyperbolic

Abstract 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 early consumption and delayed saving, then a marginal increase in steady‐state output is achieved at the cost of a much higher average inflation rate. We show that the present bias produced when households have quasi‐hyperbolic discounting causes asset returns to rise substantially; in general equilibrium, the magnitude of hyperbolic discounting found in experimental studies would lead to enormous and wildly counterfactual levels for asset returns. We contrast our results with those obtained when policy is conducted according to a Taylor‐type rule and to those obtained when households and the central bank discount geometrically.