Essays on inflation targeting, price stability and the conduct of monetary policy under imperfect credibility
The main aim of this thesis is to study the impact of lack of credibility in a transition to
price stability on both, the behaviour of the output and the optimal speed of disinflation.
The analysis takes place in an environment where the supply-side of the economy is
characterized by monopolistically competitive firms, and where there is rigidity in the
setting of prices. The effects of a disinflationary monetary policy are studied when
policy makers are committed to price stability in the strict sense of achieving and
maintaining a constant price-level. However, an expectation updating rule that
incorporate a more flexible way of modelling the evolution of agent's priors then
previously done in the literature has been employed.
Previous work by Ball (1994) and Ireland (1997) identifies the "disinflationary booms"
which accompany a disinflation program. They explain their appearance as due to
imperfect credibility. In this thesis it is demonstrated that the "disinflationary booms"
may or may not disappear in an environment with imperfect credibility, depending on
the speed of learning relative to the speed of disinflation. Regarding the optimal speed
of disinflation, this thesis suggests that in both cases of perfect and imperfect credibility
big inflations should be stopped rapidly. On the other hand, in the case of imperfect
credibility, for small inflations, the speed of disinflation decreases in comparison to the
case of perfect foresight. Also, once inflation has risen substantially, imperfect
credibility makes sizeable output losses in the transition to price stability highly likely
even when the speed of disinflation is 'optimal'.