DP454 Credibility and Stabilization

Author(s): Rudiger Dornbusch
Publication Date: September 1990
Keyword(s): Credibility, Stabilization
JEL(s): 110, 130, 300
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=454

When governments attempt stabilization why do they not undertake a programme certain to succeed? The paper discusses credibility when it is inconceivable that a programme will succeed with probability one. A cost-benefit analysis establishes an equilibrium programme that has some ex ante probability of failure, so that credibility is always less than full. The context is a one-shot game in which policy-makers are uncertain about the response of the instruments or the post-stabilization economic environment. As a positive theory of stabilization, the paper identifies the factors that increase the chances of success of a programme.