Partial credibility and policy announcements: The problem of time inconsistency in macroeconomics revisited
This paper studies the credibility of policy announcements in macroeconomics. This issue is exemplified by the problem of monetary policy design in light of an expectations-augmented Phillips curve. In contrast to reputational models of the repeated games literature, the credibility problem between the central bank and the private sector, which results from the policymaker's temptation to create surprise inflation to raise employment, cannot be eliminated. The paper shows that credibility in any sequential equilibrium is generally only partial, in that market participants do not fully believe policy announcements of low inflation rates, even if forthright policies have been implemented in all periods. Indicating reputation-building, credibility improves over time. The example is then used to show the policy implications of partial credibility. Copyright International Atlantic Economic Society 1997
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Volume (Year): 25 (1997)
Issue (Month): 4 (December)
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