Inflation Targeting, Credibility and Confidence Crises
AbstractWe study the interplay between the central bank transparency, its credibility, and the inflation 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 confirmed type of equilibrium may arise. In this case, an over-the-target inflation 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 confidence crises and ensure a unique equilibrium for the expected inflation. Moreover, even after ruling out the possibility of confidence 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 fulfilled in many states of nature.
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Bibliographic InfoPaper provided by FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil) in its series Economics Working Papers (Ensaios Economicos da EPGE) with number 653.
Date of creation: 01 Sep 2007
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Other versions of this item:
- Rafael Santos & Aloisio Araujo, 2007. "Inflation Targeting, Credibility and Confidence Crises," Working Papers Series 140, Central Bank of Brazil, Research Department.
- NEP-ALL-2007-10-06 (All new papers)
- NEP-CBA-2007-10-06 (Central Banking)
- NEP-MAC-2007-10-06 (Macroeconomics)
- NEP-MON-2007-10-06 (Monetary Economics)
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- Solange Gouvea, 2007. "Price Rigidity in Brazil: Evidence from CPI Micro Data," Working Papers Series 143, Central Bank of Brazil, Research Department.
- Ricardo Schechtman, 2007. "Joint Validation of Credit Rating PDs under Default Correlation," Working Papers Series 149, Central Bank of Brazil, Research Department.
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