Limited commitment, endogenous credibility and the challenges of price-level targeting

Arbeitspapier

This paper studies the cost of limited commitment when a central bank has the discretion to adjust policy whenever the costs of honoring its past commitments become high. Specifically, we consider a central bank that seeks to implement optimal policy in a New Keynesian model by committing to a price-level target path. However, the central bank retains the flexibility to reset the target path if the cost of adhering to it exceeds a social tolerance threshold. We find that endowing the central bank with such discretion undermines the credibility of the price-level target and weakens its effectiveness to stabilize the economy through expectations. The endogenous nature of credibility also brings novel results relative to models with exogenous timing of target resets. A much higher degree of credibility is needed to realize the stabilization benefits of commitment. Multiple equilibria also emerge, including a low credibility equilibrium with frequent target resets and high volatility.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Bank of Canada Staff Working Paper ; No. 2018-61

Classification and Topics

• Classification: Wirtschaft ; Price Level; Inflation; Deflation ; Monetary Policy
• Subject: Monetary policy framework ; Credibility ; Inflation targets

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Cateau, Gino ; Shukayev, Malik
• Event: Veröffentlichung
• (who): Bank of Canada
• (where): Ottawa
• (when): 2018

Further information

• DOI: doi:10.34989/swp-2018-61
• Handle: http://hdl.handle.net/10419/197914
• Last update: 10.03.2025, 11:44 AM CET