Effects of reputation and credibility on monetary policy: theory and evidence for Brazil

Purpose - – The purpose of this paper is to demonstrate that both the reputation of the monetary authority and the credibility of the regime of inflation targeting are important to reduce the inflation bias and the effort of the monetary authority in an emerging economy. Design/methodology/approach - – The paper develops a model which shows that the gain of credibility reduces the effort of the monetary authority in the conduct of monetary policy. The paper presents an econometric analysis for Brazil through ordinary least squares, generalized method of moments (GMM), system of equations by GMM and vector autoregressive. Findings - – The findings suggest that the reputation of the monetary authority is important to the improvement of credibility, and the gains of credibility reduce the effort of the monetary authority in the conduct of monetary policy, reducing the variations of the monetary base. Originality/value - – In the theoretical field, the study develops a model which shows that credibility is important to reduce both the inflation bias and the efforts of the monetary authority in the conduct of monetary policy. In the empirical field: first, it proposes a new index of reputation for the monetary authority; second, it demonstrates that the gain of reputation improves credibility, but also that attempts to exploit the output-inflation trade-off reduces credibility; third, the analysis found that the gains of credibility reduce the efforts of the monetary authority in the conduct of monetary policy.