Central Bank Credibility and Monetary Policy
74 Pages Posted: 24 Dec 2018
Date Written: December 24, 2018
A numerical measure of central bank credibility, which can be incorporated into a New Keynesian model under bounded rationality, is proposed and analyzed. This measure arises mainly due to the existence of the drifts in private long-term predictions, which are different from those of the central bank. It is shown that central bank credibility matters for macroeconomic stability. As the credibility increases, macroeconomic variables vary less. This generates endogenous volatility changes. Lastly, the magnitude of response of inflation to monetary policy depends on the level of credibility. This suggests that ignoring credibility changes might leads to overestimate of the cost of disinflation.
Keywords: Monetary policy, Credibility, Learning, Bounded Rationality
JEL Classification: E3, E52, E58, D8
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