The Challenge of Building Credibility
A central bank with a history of frequently missing its inflation targets announces a new, more ambitious goal of 2% inflation. Explain why firms and workers might be skeptical of this announcement and continue to expect higher inflation when making pricing and wage-setting decisions. What is the crucial factor the central bank must establish to make its new target believable?
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Economics
Economy
Introduction to Macroeconomics Course
Ch.5 Macroeconomic policy: Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
CORE Econ
Social Science
Empirical Science
Science
Analysis in Bloom's Taxonomy
Cognitive Psychology
Psychology
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Central Bank Credibility and Inflation Expectations
Consider two countries, both with a stated inflation target of 2%. The central bank in Country A has a long and consistent track record of meeting this target, earning significant public trust. In contrast, the central bank in Country B has frequently missed its target, and its policy announcements are often viewed with skepticism. If both countries experience an identical, temporary external shock that pushes current inflation to 5%, how would the public's long-term wage and price-setting behavior most likely differ between the two countries?
The Credibility Gap: Actions vs. Announcements
True or False: If a central bank has established high credibility and successfully anchored the public's inflation expectations at 2%, a sudden, temporary increase in oil prices that pushes current inflation to 5% will likely cause long-term wage negotiations to immediately incorporate an expectation of 5% future inflation.
The Challenge of Building Credibility