1. The signaling effect of raising inflation
- Author
-
Jean Barthélemy, Eric Mengus, École Nationale de la Statistique et de l'Administration Économique (ENSAE Paris), Groupement de Recherche et d'Etudes en Gestion à HEC (GREGH), Ecole des Hautes Etudes Commerciales (HEC Paris)-Centre National de la Recherche Scientifique (CNRS), and HEC Paris Research Paper Series
- Subjects
Inflation ,Economics and Econometrics ,media_common.quotation_subject ,Monetary economics ,Forward guidance ,JEL: E - Macroeconomics and Monetary Economics/E.E3 - Prices, Business Fluctuations, and Cycles/E.E3.E31 - Price Level • Inflation • Deflation ,JEL: E - Macroeconomics and Monetary Economics/E.E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit/E.E5.E52 - Monetary Policy ,JEL: E - Macroeconomics and Monetary Economics/E.E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook/E.E6.E65 - Studies of Particular Policy Episodes ,Liquidity trap ,0502 economics and business ,Credibility ,Economics ,Real interest rate ,050207 economics ,050205 econometrics ,media_common ,Great Moderation ,05 social sciences ,Forward Guidance ,Private sector ,Signaling ,Market liquidity ,8. Economic growth ,[SHS.GESTION]Humanities and Social Sciences/Business administration ,Volatility (finance) ,Reputation - Abstract
This paper argues that central bankers should raise inflation to signal their credibility to forward guidance policies. As inflation can be stabilized in normal times either because of central banker's credibility (e.g. because of reputation concerns) or because of his aversion to inflation, the private sector is unable to infer the central banker's type from observing stable inflation before a liquidity trap, jeopardizing the efficiency of forward guidance policy. We derive optimal policy in a new-Keynesian model subject to liquidity traps where agents are uncertain about the central banker's type and we show that the credible central banker can signal his type by raising inflation before a trap. We show that this signaling motive can justify level of inflation well above 2% but also that the low inflation volatility during the Great Moderation was insufficient to ensure fully efficient forward guidance when needed.
- Published
- 2018