DP10541 Trust in the Monetary Authority

Author(s): Dirk Bursian, Ester Faia
Publication Date: April 2015
Keyword(s): betrayal aversion, monetary transmission system, trust games
JEL(s): C7, C8, E0, E5, G12
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10541

Trust in policy makers fluctuates significantly over the cycle and affects the transmission mechanism. Despite this it is absent from the literature. We build a monetary model embedding trust cycles; the latter emerge as an equilibrium phenomenon of a game-theoretic interaction between atomistic agents and the monetary authority. Trust affects agents' ?stochastic discount factors, namely the price of future risk, and through this it interacts with the monetary transmission mechanism. Using data from the Eurobarometer surveys, we analyze the link between trust and the transmission mechanism of macro and monetary shocks. Empirical results are in line with theoretical ones.