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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) Downloads
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