Credibility, smooth expectation and inflation persistence

Abstract

This paper examines the situation where the public's inflationary expectation varies smoothly with current and past inflation realizations. We construct a stationary Markov perfect public equilibrium with a continuous expectations mechanism, in which government reputation plays an important role. The sustainable steady-state inflations are multiple and the degrees of persistence are indeterminate. This makes our equilibria explain not only high and persistent inflations but also equally abundant episodes of successful disinflations. Interestingly enough, the analysis here and the recent contributions to the dynamic seigniorage literature potentially may generate some observationally equivalent economic phenomena despite their marked contrasts in causes and effects.