Credible Disinflation Policy in a Dynamic Setting

Christopher Baum and Meral Karasulu ()
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Meral Karasulu: Bogazici University

No 375, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: This paper builds upon the analysis of Orphanides and Wilcox (1996) to evaluate optimal anti-inflation policy under a broader set of circumstances than considered in their work. We consider a monetary authority with two instruments--the funds rate and the discount rate--with the distinction that only movements of the latter are 'credible' alterations of the Fed's policy stance, reflecting reputational effects. The public forms expectations of inflation given realized inflation and the expected progress toward lower inflation, as evidenced by credible policy moves. Optimal policy is formulated in a stochastic, dynamic setting of the Tinbergen-Theil framework. The presence of a "cost-of-change" penalty on the sequence of discount rate adjustments generates expected trajectories for targets and policy instruments which differ considerably from those lacking such a penalty.

Keywords: disinflation; credibility; optimal policy design (search for similar items in EconPapers)
JEL-codes: E47 E51 E61 (search for similar items in EconPapers)
Pages: 36 pages
Date: 1997-06-01
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Persistent link: https://EconPapers.repec.org/RePEc:boc:bocoec:375

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