Anti-Inflationary Policies and the Issue of Credibility of Central Banks
Introduction
Anti-inflationary policies are the policies taken by the government to announce inflation target lowering it to zero, in the beginning of the year, which at that time is considered optimal. The government wants to keep the inflation level low in an economy. It is the continuous rise in the general price level of goods and services over a period of time in an economy. As we know inflation can cause serious social consequences, if it’s not perfectly anticipated, money as a measure of value or as a medium of exchange is undermined.
The issue of credibility
The announcement of the government of anti-inflation will form expectations and be embedded into contracts. Wage contracts are also signed in this period. In this circumstance, the policymaker has a chance to induce a surprise inflation leading to an increase in inflation level and a decrease in the level of unemployment. This may be desirable, particularly if the natural level of unemployment is considered too high from a social point of view, so that during the year a higher inflation would have been optimal. And as this has been undertaken by the government a number of times, the announcements are not considered credible. The private sector can foresee the consequent move by the government and does not take into account the announcement, since in the past the government induced surprise inflation, although this inducement is not the response to any change in the environment but the change in policy action of the private sector itself. This brings in the time-inconsistency problem, where there are considerable two players, private sector and the policy maker (here, government).
Knowing that the final unemployment rate would be UN, the government choose to minimise inflation by promising to drive down π to 0. The private sector then predicts the government’s final move and makes a choice regardless of the policy and forces the policy maker to make the final decision at π > 0, which means
Anti-inflationary policies are the policies taken by the government to announce inflation target lowering it to zero, in the beginning of the year, which at that time is considered optimal. The government wants to keep the inflation level low in an economy. It is the continuous rise in the general price level of goods and services over a period of time in an economy. As we know inflation can cause serious social consequences, if it’s not perfectly anticipated, money as a measure of value or as a medium of exchange is undermined.
The issue of credibility
The announcement of the government of anti-inflation will form expectations and be embedded into contracts. Wage contracts are also signed in this period. In this circumstance, the policymaker has a chance to induce a surprise inflation leading to an increase in inflation level and a decrease in the level of unemployment. This may be desirable, particularly if the natural level of unemployment is considered too high from a social point of view, so that during the year a higher inflation would have been optimal. And as this has been undertaken by the government a number of times, the announcements are not considered credible. The private sector can foresee the consequent move by the government and does not take into account the announcement, since in the past the government induced surprise inflation, although this inducement is not the response to any change in the environment but the change in policy action of the private sector itself. This brings in the time-inconsistency problem, where there are considerable two players, private sector and the policy maker (here, government).
Knowing that the final unemployment rate would be UN, the government choose to minimise inflation by promising to drive down π to 0. The private sector then predicts the government’s final move and makes a choice regardless of the policy and forces the policy maker to make the final decision at π > 0, which means
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