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Inflation and Reputation

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  • D. Backus
  • J. Driffil

Abstract

In many macroeconomic models with rational expectations, optimal policy is time inconsistent, and therefore announced policy may not be credible. This paper models the government's credibility explicitly, using Kreps and Wilson's analysis. Time-consistent optimal government policy emerges as a sequential equilibrium in a repeated game. This policy is at least as good as the inconsistent 'optimal' policy, and dominates the consistent policy when reputational effects are ignored. Thus, the analysis resolves the problem of specifying a credible optimal policy in such models. The results show why attempts to disinflate may lead to recession, even with perfectly flexible prices.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • D. Backus & J. Driffil, 1998. "Inflation and Reputation," Levine's Working Paper Archive 625, David K. Levine.
    • Handle: RePEc:cla:levarc:625
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    6. William D. Nordhaus, 1975. "The Political Business Cycle," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 42(2), pages 169-190.
    7. Howitt, Peter, 1982. "Anti-inflation policy with a skeptical public : A comment on The Meyer-Webster paper," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 17(1), pages 109-113, January.
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