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An explicit inflation target as a commitment device

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  • Libich, Jan

Abstract

This paper shows an avenue through which a numerical long-run inflation target ensures low inflation and high credibility; one that is independent of the usual Walsh incentive contract. Our novel game theoretic framework - a generalization of alternating move games - formalizes the fact that since the target is explicit (legislated), it cannot be frequently reconsidered. This 'explicitness' therefore serves as a commitment device. There are two key results. First, it is shown that if the inflation target is sufficiently rigid/explicit relative to the public's wages, low inflation is time consistent and hence credible even if the policymaker's output target is above potential. Second, it is found that the central banker's optimal explicitness level is decreasing in the degree of his patience/independence (due to their substitutability in achieving credibility). Our analysis therefore offers an explanation for the 'inflation and credibility convergence' over the past two decades as well as the fact that inflation targets were legislated primarily by countries that had lacked central bank independence like New Zealand, Canada, and the UK rather than the US, Germany, or Switzerland. We show that there exists fair empirical support for all the predictions of our analysis.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 30 (2008)
Issue (Month): 1 (March)
Pages: 43-68

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Handle: RePEc:eee:jmacro:v:30:y:2008:i:1:p:43-68

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Web page: http://www.elsevier.com/locate/inca/622617

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Citations

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Cited by:
  1. Jan Libich, 2009. "A Note on the Anchoring Effect of Explicit Inflation Targets," CAMA Working Papers 2009-21, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  2. Libich, Jan & Stehlík, Petr, 2011. "Endogenous monetary commitment," Economics Letters, Elsevier, vol. 112(1), pages 103-106, July.
  3. Jan Libich & Petr Stehlik, 2008. "Fiscal Rigidity In A Monetary Union: The Calvo Timing And Beyond," CAMA Working Papers 2008-22, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  4. Oleg KITOV & Ivan KITOV, 2012. "Inflation And Unemployment In Switzerland: From 1970 To 2050," Journal of Applied Economic Sciences, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, vol. 7(2(20)/ Su), pages 141-156.
  5. Jan Libich & Andrew Hughes Hallett & Petr Stehlik, 2007. "Monetary And Fiscal Policy Interaction With Various Degrees And Types Of Commitment," CAMA Working Papers 2007-21, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  6. Andrew Hughes Hallett & Jan Libich, 2007. "Fiscal-monetary Interactions: The Effect of Fiscal Restraint and Public Monitoring on Central Bank Credibility," Open Economies Review, Springer, vol. 18(5), pages 559-576, November.

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