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Title: Monetary Policy and Reputational Equilibria: A Resolution of the Non-Uniqueness Problem

Author(s): A Al-Nowaihi and Paul L Levine

Publication Date: August 1992

Keyword(s): Credibility, Monetary Policy, Multiple Equilibria and Reputational Equilibria

Programme Area(s): International Macroeconomics

Abstract: This paper provides a resolution of the non-uniqueness of reputational equilibria in the Barro-Gordon monetary policy game. We introduce a `chisel-proof' credibility condition which ensures that in response to a small deviation from the low inflation rate by the central bank, it never pays for the private sector to acquiesce. This condition, which amounts to a refinement of the subgame perfect equilibrium, endogenizes the punishment length of the private sector's trigger strategy. The result is that a unique low-inflation outcome can be enforced as a sub-game perfect and credible non-cooperative equilibrium. A combination of discount factors close to unity for both players and short-wage contracts is the desirable combination to drive the best enforceable inflation outcome towards the ideal zero rate.

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Bibliographic Reference

Al-Nowaihi, A and Levine, P. 1992. 'Monetary Policy and Reputational Equilibria: A Resolution of the Non-Uniqueness Problem'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=702