Saturday, April 25, 2009

Central Bank credibility

We have shown that,in order to achieve disinflation at a low cost,the public,s expectation of the inflation rate must be reduced. This will shift the SRAS curve down so that lower inflation is not "paid for"by lost output and jobs.However,merely announcing a disinflationary policy may not be enough to change the public,s expectations.An additional,crucial factor is the central bank credibility: For households and businesses to respond to an announced "commitment" to reducing inflation,the public must believe that the central bank will in fact carry out its disinflationary promises. The public might not believe the central bank because disinflationnary entails economic costs--lost output and jobs--which are likely to be politically unpopular. If the public believes that policymakers will back off,inflationary expectations will change very slowly until the central bank convinces the public of its credibility. The Other times, other places box illustrates the role of credibility in reducing inflation in the United States and Japan.

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