Inflation and Reputation
AbstractIn 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.
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Bibliographic InfoPaper provided by David K. Levine in its series Levine's Working Paper Archive with number 625.
Date of creation: 15 Apr 1998
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Other versions of this item:
- Backus, David & Driffill, John, 1985. "Inflation and Reputation," American Economic Review, American Economic Association, American Economic Association, vol. 75(3), pages 530-38, June.
- David Backus & John Driffill, 1984. "Inflation and Reputation," Working Papers, Queen's University, Department of Economics 560, Queen's University, Department of Economics.
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- Chappell, Henry W, Jr, 1983. "Presidential Popularity and Macroeconomic Performance: Are Voters Really So Naive?," The Review of Economics and Statistics, MIT Press, vol. 65(3), pages 385-92, August.
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