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Partial credibility and policy announcements: The problem of time inconsistency in macroeconomics revisited

  • Silke Reeves
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    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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    File URL: http://hdl.handle.net/10.1007/BF02298345
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    Article provided by International Atlantic Economic Society in its journal Atlantic Economic Journal.

    Volume (Year): 25 (1997)
    Issue (Month): 4 (December)
    Pages: 344-357

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    Handle: RePEc:kap:atlecj:v:25:y:1997:i:4:p:344-357
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    1. Benoit, Jean-Pierre & Krishna, Vijay, 1985. "Finitely Repeated Games," Econometrica, Econometric Society, vol. 53(4), pages 905-22, July.
    2. Drew Fudenberg & David K. Levine, 1988. "Reputation, Unobserved Strategies, and Active Supermartingales," Working papers 490, Massachusetts Institute of Technology (MIT), Department of Economics.
    3. David Backus & John Driffill, 1984. "Inflation and Reputation," Working Papers 560, Queen's University, Department of Economics.
    4. Milgrom, Paul & Roberts, John, 1982. "Predation, reputation, and entry deterrence," Journal of Economic Theory, Elsevier, vol. 27(2), pages 280-312, August.
    5. Cukierman, A. & Liviatan, N., 1991. "The Dynamics of Optimal Gradual Stabilizations," Papers 34-91, Tel Aviv.
    6. Barro, Robert J., 1986. "Reputation in a model of monetary policy with incomplete information," Journal of Monetary Economics, Elsevier, vol. 17(1), pages 3-20, January.
    7. David Kreps & Robert Wilson, 1998. "Sequential Equilibria," Levine's Working Paper Archive 237, David K. Levine.
    8. Kenneth Rogoff, 1986. "Reputational Constraints on Monetary Policy," NBER Working Papers 1986, National Bureau of Economic Research, Inc.
    9. Friedman, James W, 1971. "A Non-cooperative Equilibrium for Supergames," Review of Economic Studies, Wiley Blackwell, vol. 38(113), pages 1-12, January.
    10. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
    11. Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September.
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