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Could Reputation-Bias be a Bigger Problem than Inflation-Bias?

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  • James Forder

Abstract

The theory of policy credibility has been influential in both the design of monetary policymaking institutions and in the implementation of policy. In particular, the idea that `reputation` is important has been widely accepted. However, careful attention to its assumptions and implications of the theory reveals many sources of doubt as to its empirical value. First, the theory is implausible, and even if taken seriously does not point to many of the conclusions frequently supposed to be based on it. Second, evidence suggests the theory is false. Third, even policymakers who profess themselves concerned about the maintenance of credibility do not behave consistently in the way the theory says they should. Although many policy proposals ostensibly based on the theory of credibility therefore seem to lack persuasive support, the idea of credibility still poses a danger to effective policymaking since it creates motives for excessively contractionary policy. Although it is frequently asserted that monetary policy can have no long-term effects on economic performance, the idea that a loss of `reputation` will have lasting detrimental effects appears to motivate much policy. In the absence of convincing arguments that reputation - in its technical sense - is important, this would seem to be undesirable and probably dangerous.

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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 22.

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Date of creation: 01 Oct 2000
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Handle: RePEc:oxf:wpaper:22

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Keywords: central bank independence; policy credibility; deflation;

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  1. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
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  4. Goodhart, Charles A E & Huang, Haizhou, 1998. "Time Inconsistency in a Model with Lags, Persistence, and Overlapping Wage Contracts," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 378-96, July.
  5. Backus, David & Driffill, John, 1985. "Rational Expectations and Policy Credibility Following a Change in Regime," Review of Economic Studies, Wiley Blackwell, vol. 52(2), pages 211-21, April.
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  7. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
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  10. McCallum, Bennett T., 1997. "Crucial issues concerning central bank independence," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 99-112, June.
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  12. Posen, Adam, 1998. "Central Bank Independence and Disinflationary Credibility: A Missing Link?," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 335-59, July.
  13. Jonung, L. & Laidler, D., 1988. "Are Perceptions Of Inflation Rational? Some Evidence For Sweden," UWO Department of Economics Working Papers 8808, University of Western Ontario, Department of Economics.
  14. Cukierman, Alex, 1994. "Central Bank Independence and Monetary Control," Economic Journal, Royal Economic Society, vol. 104(427), pages 1437-48, November.
  15. Peter Nicholl & David Archer, 1992. "An announced downward path for inflation," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 55, December.
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