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Credibility Dynamics and Inflation Expectations

Rumen Kostadinov () and Francisco Roldán ()

Department of Economics Working Papers from McMaster University

Abstract: We study the optimal design of a disinflation plan by a planner who lacks commitment and has imperfect control over inflation. The government’s reputation for being committed to the plan evolves as the public compares realized inflation to the announced targets. Reputation is valuable as it helps curb inflation expectations. At the same time, plans that are more tempting to break lead to larger expected reputational losses in the ensuing equilibrium. Taking these dynamics into consideration, the government announces a plan which balances promises of low inflation with dynamic incentives that make them credible. We find that, despite the absence of inflation inertia in the private economy, a gradual disinflation is preferred even in the zero-reputation limit.

Keywords: Imperfect credibility; reputation; optimal monetary policy; time inconsistency (search for similar items in EconPapers)
JEL-codes: C73 E52 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2021-04
New Economics Papers: this item is included in nep-mac and nep-mon
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Working Paper: Credibility Dynamics and Disinflation Plans (2020) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:mcm:deptwp:2021-06

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