## Credibility Dynamics and Disinflation Plans

_IMF Working Papers, June 5, 2020_

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**Canonical URL:** [Credibility Dynamics and Disinflation Plans](https://www.imf.org/en/publications/wp/issues/2020/06/05/credibility-dynamics-and-disinflation-plans-49375)

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## Bibliographic details
- Authors: Bomakara Heng (National Bank of Cambodia), Francisco Roldán
- Published: June 5, 2020
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513546124.001

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### Summary
- Authors: Bomakara Heng (National Bank of Cambodia), Francisco Roldán
- Date: June 5, 2020
- Core research question: Optimal design of a disinflation plan by a planner who lacks commitment.
- Central mechanism studied: Tradeoff between surprise inflation and building reputation, where reputation is defined as the private sector's belief that the Central bank is committed to the plan.
- Main conclusion: Even in the zero reputation limit, a gradual disinflation is preferred despite the absence of inflation inertia in the private economy.

### Key findings
- Some disinflation plans are harder to sustain because "paving out future grounds with temptation" leads to a negative drift of reputation in equilibrium.
- Successful plans balance promises of lower inflation with dynamic incentives that increase credibility.
- The planner anticipates interactions between announced promises and reputation dynamics when announcing the disinflation plan.
- Preference for gradual disinflation holds even when reputation is effectively zero and when the private economy lacks inflation inertia.

### Model insights and mechanisms
- Reputation is modeled as the private sector's belief about the Central bank's commitment to the announced plan.
- A tradeoff exists between:
  - Surprise inflation (deviating from the announced plan), and
  - Building reputation (sustaining low inflation expectations over time).
- Dynamic incentives embedded in the announced plan can offset temptations to deviate and prevent negative reputation drift.
- The equilibrium features endogenous reputation dynamics; some plans induce a negative drift of reputation, making them unsustainable.

### Policy implications
- When designing disinflation plans without full commitment, policymakers should:
  - Balance short-term promises of lower inflation with mechanisms that create credible dynamic incentives.
  - Favor gradual disinflation strategies even when initial credibility is extremely low or absent.
  - Recognize that certain plan designs may inherently erode reputation over time and should be avoided.

### Subject classifications and keywords
- Subject: Disinflation, Inflation, Inflation targeting, Monetary policy, Prices, Tax incentives
- Keywords: choice of policy, Disinflation, equilibrium announcement, government being, government credibility, government's choice, high-inflation stage Nash, Imperfect credibility, Inflation, inflation plan, Inflation targeting, Nash inflation, optimal monetary policy, Phillips curve, punishment regime, rational government, reputation, time inconsistency, WP

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_Source: https://www.imf.org/en/publications/wp/issues/2020/06/05/credibility-dynamics-and-disinflation-plans-49375_