Credibility Dynamics and Disinflation Plans

Author/Editor:

Rumen Kostadinov ; Francisco Roldán

Publication Date:

June 5, 2020

Electronic Access:

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary:

We study the optimal design of a disinflation plan by a planner who lacks commitment. Having announced a plan, the Central banker faces a tradeoff between surprise inflation and building reputation, defined as the private sector's belief that the Central bank is committed to the plan. Some plans are harder to sustain: the planner recognizes that paving out future grounds with temptation leads the way for a negative drift of reputation in equilibrium. Plans that successfully create low inflationary expectations balance promises of lower inflation with dynamic incentives that make them more credible. When announcing the disinflation plan, the planner takes into account these anticipated interactions. We find that, even in the zero reputation limit, a gradual disinflation is preferred despite the absence of inflation inertia in the private economy.

Series:

Working Paper No. 20/85

Subject:

English

Publication Date:

June 5, 2020

ISBN/ISSN:

9781513546124/1018-5941

Stock No:

WPIEA2020085

Format:

Paper

Pages:

32

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