Inflation and Reputation

David Backus and Edward Driffill ()

Working Paper from Economics Department, Queen's University

Abstract: In many macroeconomic models with rational expectations, optimal policy is time inconsistent, and therefore announced policy may not be credible. This paper models the government's credibility explicitly, using Kreps and Wilson's analysis. Time-consistent optimal government policy emerges as a sequential equilibrium in a repeated game. This policy is at least as good as the inconsistent 'optimal' policy, and dominates the consistent policy when reputational effects are ignored. Thus, the analysis resolves the problem of specifying a credible optimal policy in such models. The results show why attempts to disinflate may lead to recession, even with perfectly flexible prices.

Pages: 21 pages
Date: 1984
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Citations: View citations in EconPapers (7)

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Working Paper: Inflation and Reputation (1998)
Journal Article: Inflation and Reputation (1985)
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Persistent link: https://EconPapers.repec.org/RePEc:qed:wpaper:560

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