Contacts, Credibility and Common Knowledge: Their Influenceon Inflation Convergence

March 1, 1992

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

In this paper three possible reasons are examined for a sluggish inflation response to a hard currency peg. Models of overlapping wage contracts are analyzed and shown to generate little inertia. This contrasts with the effects of government credibility and the speed of private sector learning, which are shown to have a major impact on the speed of inflation adjustment. But even if individual agents believe the government will not devalue, it is shown that inflation inertia can still arise if these expectations are not common knowledge.

Subject: Conventional peg, Economic theory, Exchange rates, Foreign exchange, Inflation, Inflation persistence, Prices, Rational expectations

Keywords: Conventional peg, current price price level, exchange rate, exchange rate peg, Exchange rates, Inflation, inflation inertia, Inflation persistence, price level, price level jump, price level rate, price level rising, Rational expectations, WP

Pages:
24
Volume:
1992
DOI:
https://doi.org/10.5089/9781451981773.001
Issue:
026
Series:
Working Paper No. 1992/026
Stock No:
WPIEA0261992
ISBN:
9781451981773
ISSN:
1018-5941

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Notes

Also published in Staff Papers, Vol. 40, No. 1, March 1993.

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