The Signaling Effect of Raising Inflation

52 Pages Posted: 18 Jul 2016 Last revised: 17 Jan 2017

See all articles by Jean Barthelemy

Jean Barthelemy

Banque de France

Eric Mengus

HEC Paris - Economics & Decision Sciences

Date Written: January 9, 2017

Abstract

This paper argues that central bankers should temporarily raise inflation when anticipating liquidity traps to signal their credibility to forward guidance policies. As stable inflation in normal times either stems from central banker's credibility, e.g. through reputation, or from his aversion to inflation, the private sector is unable to infer the central banker's type from observing stable inflation, jeopardizing the efficiency of forward guidance policy. We show that this signaling motive can justify temporary deviations of inflation from target well above 2% but also that the low inflation volatility during the Great Moderation was insufficient to ensure fully efficient forward guidance when needed.

Keywords: Forward Guidance, Inflation, Signaling

JEL Classification: E31, E52, E65

Suggested Citation

Barthelemy, Jean and Mengus, Eric, The Signaling Effect of Raising Inflation (January 9, 2017). HEC Paris Research Paper No. ECO/SCD-2016-1162. Available at SSRN: https://ssrn.com/abstract=2808461 or http://dx.doi.org/10.2139/ssrn.2808461

Jean Barthelemy

Banque de France ( email )

Paris
France

Eric Mengus (Contact Author)

HEC Paris - Economics & Decision Sciences ( email )

Paris
France

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