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Credibility of Policies Versus Credibility of Policymakers

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  • Mr. Paul R Masson
  • Allan Drazen

Abstract

Standard models of policy credibility, defined as the expectation that an announced policy will be carried out, emphasize the preferences of the policymaker, and the role of tough policies in signalling toughness and raising credibility. Whether a policy is carried out, however, will also reflect the state of the economy. We present a model in which a policymaker maintains a fixed parity in good times, but devalues if the unemployment rate gets too high. Our main conclusion is that if there is persistence in unemployment, observing a tough policy in a given period may lower rather than raise the credibility of a no-devaluation pledge in subsequent periods. We test this implication on data for the interest rate differential between France and Germany and find support for our hypothesis.

Suggested Citation

  • Mr. Paul R Masson & Allan Drazen, 1994. "Credibility of Policies Versus Credibility of Policymakers," IMF Working Papers 1994/049, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:1994/049
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    More about this item

    Keywords

    WP; policy credibility; government debt accumulation; anti-inflationary policies increase; objective function; no-devaluation rule; expansionary policy; policy stance; tough government; policy instrument; critical value; policy convergence; second period problem; Unemployment rate; Unemployment; Inflation;
    All these keywords.

    JEL classification:

    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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