Inflation targeting, credibility and confidence crises

Aloisio Araujo and Rafael Santos

No 653, FGV EPGE Economics Working Papers (Ensaios Economicos da EPGE) from EPGE Brazilian School of Economics and Finance - FGV EPGE (Brazil)

Abstract: We study the interplay between the central bank transparency, its credibility, and the ination target level. Based on a model developed in the spirit of the global games literature, we argue that whenever a weak central bank adopts a high degree of transparency and a low target level, a bad and self conrmed type of equilibrium may arise. In this case, an over-the-target ination becomes more likely. The central bank is considered weak when favorable state of nature is required for the target to be achieved. On the other hand, if a weak central bank opts for less ambitious goals, namely lower degree of transparency and higher target level, it may avoid condence crises and ensure a unique equilibrium for the expected ination. Moreover, even after ruling out the possibility of condence crises, less ambitious goals may be desirable in order to attain higher credibility and hence a better coordination of expectations. Conversely, a low target level and a high central bank transparency are desirable whenever the economy has strong fundamentals and the target can be fullled in many states of nature.

Date: 2007-09-01
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Working Paper: Inflation Targeting, Credibility and Confidence Crises (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:fgv:epgewp:653

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