Central bank credibility and the persistence of inflation and inflation expectations

Jonathan Davis

No 117, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: This paper introduces a model where agents are unsure about the central bank's inflation target. They believe that the central bank's inflation target could lie between two extremes, and their beliefs vary depending on the central bank's stock of credibility. They form the expectations used in price and wage setting using this perceived inflation target, and they use past observations of inflation to update their beliefs about the credibility of the central bank. Thus a series of high inflation observations can lead them to believe (incorrectly) that the central bank has adopted a high target. High inflation expectations are incorporated into price and wage setting decisions, and a transitory shock to inflation can become very persistent. The model with endogenous credibility can match the volatility and persistence of both inflation and measures of long-term inflation expectations that we see in the data. The model is then calibrated to match the observed levels of Federal Reserve credibility in the 1980s and the 2000s. By simply changing the level of credibility, holding all else fixed, the model can explain nearly all of the observed changes in the volatility and persistence of inflation and inflation expectations in the U.S. from the 1980s to today.

Keywords: Price; levels (search for similar items in EconPapers)
JEL-codes: D83 E31 E50 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2012
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://www.dallasfed.org/-/media/documents/resear ... papers/2012/0117.pdf Full text (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:117

Access Statistics for this paper

More papers in Globalization Institute Working Papers from Federal Reserve Bank of Dallas Contact information at EDIRC.
Bibliographic data for series maintained by Amy Chapman (amy.chapman@dal.frb.org).