WITHOUT NEGLECTING THE ECONOMIC GROWTH: MONETARY POLICY, CREDIBILITY, AND INFLATION TARGETING IN AN IS-MP MODEL

Transcription

1 WITHOUT NEGLECTING THE ECONOMIC GROWTH: MONETARY POLICY, CREDIBILITY, AND INFLATION TARGETING IN AN IS-MP MODEL Hldr Frrira d Mndonça Gabril Caldas Mons TD. Msrado m Economia Aplicada FEA/UFJF 03/009 Juiz d Fora 009

2 Wihou Nglcing h Economic Growh: Monar Polic, Crdibili, and Inflaion Targing in an IS-MP Modl Hldr Frrira d Mndonça Fluminns Fdral Univrsi Dparmn of Economics (Brazil) and Naional Council for Scinific and Tchnological Dvlopmn (CNPq) Posal addrss: Rua Dr. Sodré, 59 Vila Suíça Migul Prira Rio d Janiro CEP: Brazil mail addrss: hldrfm@homail.com Gabril Caldas Mons Fluminns Fdral Univrsi Dparmn of Economics (Brazil) Posal addrss: Tv. Dos Ourivs, 55 Pndoiba, Nirói Rio d Janiro CEP: Brazil mail addrss:gabrilmons@homail.com Absrac This aricl shows h ffc causd b crdibili on inrs ra sings in an conom wih inflaion arging. Wih his innion, i is prsnd a horical modl which aims a showing h implicaions of crdibili for an opimal monar polic srag (hrough inrs ra sings) implmnd b an inflaion arging cnral bank. I is argud ha whn crdibili incrass i rquirs smallr inrs ra variaions in ordr o conrol inflaion and kp i convrging o h arg. In addiion, his sud analzs h impacs of crdibili and monar polic hrough inrs ra sings, on invsmn and, consqunl, on oupu quilibrium. Th findings indica ha whn crdibili is high (low) h public is inclind o bhav forward-looking (backward-looking). Concrning inflaion arging srag, a forward-looking bhavior suggss ha inflaion xpcaions ar mor anchord o h inflaion arg maning ha h srag is srving is nds. Las bu no las, a high crdibili implis a low crowding ou ffc, which in urn conribus o a mor fficin fiscal polic (lss loss in h oupu du o an incras in h inrs ra). K words: inflaion arging, monar polic, inrs ra, crdibili, oupu. JEL classificaion: E4, E5.

3 . Inroducion Macroconomic hor is moving oward a nw consnsus rgarding h rol of monar polic and how cnral banks should ac considring a world surroundd b uncrainis. Sinc h conribuions of Fridman (968), Kdland and Prsco (977) and Barro and Gordon (983a and 983b), cnral banks amp o ac hrough rulbasd policis in ordr o avoid h problms of im inconsisnc and loss of crdibili as wll as o rduc uncrainis. Th concp of crdibili is conrovrsial and has diffrn inrpraions in conomic liraur. According o Blackburn and Chrisnsn (989), crdibili can b undrsood as blifs abou h currn and fuur courss of h conomic policis, which ar consisn wih h program originall announcd b policmakrs. Drazn (000) prsns wo disinc concps abou crdibili: h crdibili of h policmakr and h crdibili of h polic. Th firs mans ha h policmakr will amp o do xacl wha h sas, whil h scond could b hough of as h xpcaion ha polic will b carrid ou. In a gnral wa, monar polic is considrd crdibl if h cnral bank follows a rul (or a srag) which is no subjc o h dnamic inconsisnc problm. Taking ino considraion an inflaion arging ssm, h public s xpcaions hav a crucial rol. In pracic, h mos usd ani-inflaionar poliical rul has bn h announcmn of inrvals for inflaion flucuaion. In ordr o improv crdibili and hus h abili o guid public s xpcaions, h cnral bank amps o dvlop and srngh is rpuaion. Th basic ida is ha wih a high rpuaion, h accurac of h public s inflaion forcas is improvd and, as a consqunc, cnral bank s accounabili is incrasd. In ohr words, rpuaion and crdibili can considrabl amliora h ffcivnss of monar polic sinc h incras h confidnc of h public on xpcaions rgarding fuur cnral bank s acions. As poind ou b Drazn (000, p. 68): A br wa of hinking abou rpuaion is in rms of an infrnc problm in forming xpcaions of a policmakr s fuur acions. ( ) Sinc w mak infrncs abou fuur bhavior basd on wha has bn obsrvd in h pas, h focus is on how pas obsrvd acions lad on o xpc fuur bhavior of a givn sor, ha is, srv o build a rpuaion for fuur acions. For an analsis of his liraur, s Goodfrind and King (997), Svnsson, (999a, 999b, 003), Woodford (007), and Goodfrind (007). 3

4 Du o h fac ha h cnral bank can influnc h forward-looking bhavior of h public in ordr o affc h conomic prformanc hrough is policis, rpuaion prforms a rlvan rol in his framwork. Undr his prspciv, polic signals from crdibl monar auhoriis (wih high rpuaions) will b br undrsood b h public impling a mor ffciv monar ransmission mchanism (hrough xpcaions) and a lowr cos of disinflaion. This aricl shows h ffc causd b crdibili on inrs ra sings in an conom wih xplici inflaion arging. As Goodfrind (007, p. 63) srssd: crdibili mus anchor inflaion xpcaions so ha a cnral bank can manipula ral inrs ras rliabl wih a nominal inrs ra polic insrumn o manag aggrga dmand. In his sns, i is prsnd a horical modl which aims a showing h implicaions of crdibili for an opimal monar polic srag hrough inrs ra sings implmnd b an inflaion arging cnral bank. I is argud ha whn crdibili incrass i rquirs smallr inrs ra variaions in ordr o conrol inflaion and kp i convrging o h arg. Morovr, his sud also analzs h impacs of crdibili and monar polic hrough inrs ra sings, on invsmn and, consqunl, on oupu quilibrium. Th rmaindr of his aricl is organizd in h following wa. Th scond scion prsns h imporanc of crdibili for monar polic. Th hird scion approachs h rol of inflaion arging cnral banks, prsns a modl rgarding h rol of monar polic hrough an opimal inrs ra srag undr an xplici flxibl inflaion arging rgim, and analzs h influnc of crdibili for his opimal polic. Th fourh scion prsns h implicaions of crdibili and h opimal monar polic for h oupu quilibrium, highlighing h bhavior of aggrga dmand. Finall, h fifh scion prsns h concluding rmarks.. Inflaion arging faurs In conras o simpl polic ruls, h inflaion arging allows h cnral bank o us h insrumns oghr wih all rlvan informaion o achiv h arg. Furhrmor, his monar rgim nabls h us of discrionar policis wihou impling a loss of crdibili. In ohr words, inflaion arging rprsns a cas whr hr is consraind discrion, as poind ou b Brnank (003, p. ): Undr consraind discrion, h cnral bank is fr o do is bs o 4

5 sabiliz oupu and mplomn in h fac of shor-run disurbancs, wih h appropria cauion born of our imprfc knowldg of h conom and of h ffcs of polic (his is h "discrion" par of consraind discrion). Howvr, a crucial proviso is ha, in conducing sabilizaion polic, h cnral bank mus also mainain a srong commimn o kping inflaion and, hnc, public xpcaions of inflaion firml undr conrol (h consraind par of consraind discrion). Th nw macroconomic consnsus implis ha h ffc causd b monar polic managmn on ral acivi ma no b nglcd. Goodfrind and King (997) highligh boh posiiv and normaiv implicaions. In rlaion o h posiiv viw, conomic flucuaions ar associad wih monar polic. Basd on normaiv prspciv, aggrga dmand mus b managd b monar polic in ordr o rach fficin macroconomic oucoms. In shor, nowadas a s of characrisics is considrd ssnial for a good prformanc of cnral banks in h conducion of h monar polic, which in urn srnghns h choic of an inflaion arging rgim as a nominal anchor. Mishkin (000) highlighs svn poins: (i) pric sabili should b h ovrriding, long-run goal of monar polic; (ii) an xplici nominal anchor should b adopd; (iii) a cnral bank should b goal dpndn; (iv) a cnral bank should b insrumn indpndn; (v) a cnral bank should b accounabl; (vi) a cnral bank should srss ransparnc and communicaion, and; (vii) a cnral bank should also hav h goal of financial sabili. Inflaion arging rgim has as is main faur h official announcmn of rangs for inflaion flucuaions and h xplici rcogniion ha h main objciv of h monar polic is o assur a low and sabl inflaion ra. Morovr, his monar rgim conribus o rduc uncrainis abou h goals and insrumns of monar polic wihou prcluding polic acivism, and provids a srag ha allows for h pursui of objcivs ohr han pric sabili in a mor disciplind and consisn mannr. Inflaion arging hlps o rduc uncrain abou h fuur cours of inflaion and guids xpcaions bcaus i provids monar polic wih a nominal anchor and improvs h cnral bank ransparnc. Sinc inflaion arging rprsns a srag concrnd wih bringing boh inflaion and inflaion xpcaions o h announcd arg as wll as rducing h For an analsis rgarding inflaion arging, cnral bank ransparnc and hir ffcs on inrs ra, s d Mndonça and Simão Filho (007), Mons (008), and Oriro and Nvs (008). 5

6 uncrainis and boh sacrific raios and oupu volaili, his framwork pushs cnral banks o dvlop crdibili in ordr o improv h public s xpcaions. Hnc, i is xpcd ha crdibl inflaion args srnghn forward-looking bhavior on h simaion of inflaion and hus wakn h wigh of pas inflaion. In ohr words, inflaion xpcaions pla a fundamnal rol in his nvironmn. Thrfor, basd on an inflaion arging ssm, crdibili is crucial for is succss, bcaus i hlps incrasing h spd of convrgnc of inflaion xpcaions o h inflaion arg. Nowihsanding, i is imporan o no ha crdibili is buil ovr im. As a consqunc, inflaion arging will no rduc inflaion xpcaions quickl, bu rahr i will do so graduall ovr im. 3. Opimal inrs ra rul undr inflaion arging Aiming a analzing h consqunc of h crdibili on public s xpcaions and hus on monar polic, a horical modl is dvlopd in ordr o prsn h inrs ra sing b h cnral bank in h managmn of h monar polic aking ino accoun an xplici flxibl inflaion arging rgim. 3 A firs sp in h modl is o show how h oupu () is influncd b h ral inrs ra (r) and b h xpcaions of h public rgarding oupu variaion (E( )). Thrfor, i is assumd ha () = A E ( ) δ r, δ > 0 whr A is h sum of xognous muliplid-up dmands. I is imporan o highligh ha a divrgnc bwn h xpcd inrs ra and h quilibrium inrs ra implis non-ngligibl ffcs on oupu xpcaions. Whn h xpcd inrs ra is lowr han h quilibrium inrs ra, h ffc on h xpcd oupu variaion is posiiv (h conrar is also ru). Hnc, () E ( ) = X b[ E ( r ) ] r, whr, X is a vcor of xplanaor variabls. Th modl considrs h possibili of diffrnc bwn h currn oupu and h ponial oupu ( ). In quilibrium, h ffcs causd b xpcaions ar 3 Rcn mpirical analsis for h Brazilian cas shows ha highr crdibili implis lowr variaions in h inrs ra for conrolling inflaion (s d Mndonça, 007; and d Mndonça and d Guimarãs Souza, G.J., 009). 6

7 ngligibl and h oupu is dfind b h inrs ra ha qualizs o, ha is, (3) = A δ r. Taking ino accoun quaions () and (3), h oupu gap is givn b (4) = E ( ) δ ( r r ). Th inrpraion of h quaion abov is ha h oupu gap dpnds on boh divrgncs bwn h xpcd ral inrs ra and h quilibrium inrs ra (s quaion ) and bwn obsrvd inrs ra of h prvious priod and h quilibrium inrs ra. In his modl h priva conom is rprsnd b an augmnd Phillips curv (backward-looking) wih inflaion inria ffcs. Morovr, h Phillips curv quaion rprsns a consrain o h modl and rvals h rad-off bwn inflaion and oupu gap. (5) π = θπ ( θ ) E ( π ) α( ) ε, ε ~ N(0,σ ), 0 < θ < and α > 0. According o quaion (5), inflaion a ( π ) dpnds on: pas inflaion (inria); inflaion xpcaion buil a - for inflaion a priod ; and h oupu gap a priod - which mans ha if h cnral bank innds o rduc inflaion, h cos of disinflaion is no ngligibl. 4 Th modl assums ha h social wlfar funcion is givn b h cnral bank loss funcion, suggsing ha h cnral bank is concrnd wih inflaion and oupu. Hnc, (6) L λ π π whr, λ > 0 T = ( ) ( ) λ rprsns h wigh cnral bank givs o oupu gap. Th jusificaion for h us of h doubl lag iming assumpions and hncπ mach h viw of h Bank of England (999). According o Carlin and Soskc (006, p. 53): Th doubl lag srucur ( ) mphasizs ha a dcision akn oda b h cnral bank o rac o a shock will onl affc h inflaion ra wo priods lar ( ). Whn h conom is disurbd in h currn priod (priod zro), h cnral bank looks ahad o h implicaions for inflaion and ss h inrs ra so as o drmin, which in urn drmins h dsird valu of π. Sinc h cnral 4 Th opion for a linar Phillips curv rahr han a non-linar or an asmmric on is sufficin for h purpos of his aricl. Hnc, i is imporan o clarif ha is simplici dos no affc h rsuls of his modl. 7

8 bank can onl choos and π b is inrs ra dcision, is loss funcion aks h form prsnd hrough quaion (6). Wih h objciv o find h opimal monar polic, h subsiuion of quaion (5) ino quaion (6) is mad and h rsul is minimizd wih rspc o, ha L T is, = ( ) ( ) 0 α π π λ = T λ (7) ( π ) = ( ) π. α. Thus, h opimal monar rul corrsponds o Making us of quaion (5) h abov quaion bcoms λ T (8) ) α = [ θπ ( θ ) E ( π π ] rwrin as: (9) (0) ( ) α Taking ino considraion quaions (4) and (5) h rsul abov ma b λ α E ( ) δ( r r ) = α T θ θπ ( θ) E ( π) α( ) ( θ) E ( π ) π. Rarranging h quaion abov o find opimal inrs ra srag, hn r E r = ( ) α T ( ) ( ) ( ) ( ) ( ) { θ E π θe π θ π π θα }. δ δ α λ Sinc h currn inrs ra affcs h conom wih lags, and ha his ffc on oupu occurs bfor h ffc on inflaion du o h ransmission mchanism of monar polic, h loss funcion ma b rwrin as L λ, which in urn, implis ha h prvious quaion T = ( ) ( π π ) corrsponds o. () ( r r ) = E ( ) α δ δ ( α λ ) { ( ) ( ) ( ) ( )} T θ E π θe π θ π π θα, or ( r r ) = { ( ) ( ) ( ) ( )} T γ E ( ) τ θ E π θ E π θ π π θα whr, δ α = τ and γ δ =. ( α λ) 8

9 Th quaion abov rprsns an opimal inrs ra rspons for an inflaion arging cnral bank (MP curv in h modl). 5 I capurs h ida sad b Zimmrmann (003) ha h cnral bank uss all availabl informaion rgarding currn and fuur courss of boh inflaion and h ral sid of h conom in an amp o sabiliz inflaion and h oupu gap a h sam im. Furhrmor, i is imporan o no ha du o h laggd ffcs of monar polic, h cnral bank, for insanc, nds o rac o inflaion forcass. If h inflaion forcas indicas ha inflaion will ris, h cnral bank should rais inrs ra bfor acual inflaion sar o ris and vic-vrsa. Th inrs ra srag rprsnd b quaion () spcifis h magniud in which h inrs ra mus b changd in racion o changs in inflaion ra, inflaion xpcaions, xpcaions of fuur oupu chang, and oupu gap. Morovr, whn a dcras in inflaion followd b mporar oupu losss is a rsul of cnral bank s rsponss, h inrs ra rul is opimal in h sns ha marginal uili and marginal cos of monar polic acions ar qualizd. Equaion () allows obsrving imporan implicaions for h analsis rgarding h ffcs from crdibili o h opimal monar polic. In his sns, h paramrs θ andτ pla a crucial rol in his analsis (schm shows h cass of low and high crdibili and is implicaions for h monar polic managmn). Whn hr xiss a high (low) crdibili h public will bhav basd on a forward-looking (backwardlooking) mannr. Thus, aking ino considraion θ, i is obsrvd ha a smallr (largr) valu implis ha inflaion xpcaions bcom mor rlvan han currn inflaion for h inrs ra rspons. I is imporan o srss ha a high crdibili allows h cnral bank aks ino accoun in is racion funcion boh dparurs of inflaion from inflaion arg and oupu gap. In ohr words, h cnral bank s bhavior is closr o flxibl inflaion arging srag han sric inflaion arging srag (s schm ). Du o a srag clos o flxibl inflaion arging (sric inflaion arging) implis high (low) valus of α, λ, and δ, h consqunc is a low (high) τ. In brif, a low (high) valu of τ implis a wak (srong) racion of inrs ra. 5 MP curv is h cnral bank racion as suggsd b Romr (000). 9

10 Schm Effcs from crdibili Crdibili High Low Forward looking bhavior Backward looking bhavior θ θ rspons E(π) rspons π rspons E(π) rspons π Flxibl IT Sric IT High α, λ, δ Low α, λ, δ Low τ High τ (r - r) as monar polic (r - r) igh monar polic 4. Aggrga dmand, quilibrium, and monar polic In ordr o undrsand how h monar polic affcs aggrga dmand, h drminaion of consumpion and invsmn ar fundamnal (Romr, 00). Thrfor, invsmn and consumpion funcions ar prsnd and h oupu quilibrium is analzd aking ino considraion wo disinc cass: (i) crdibili bing 0

11 buil - as a consqunc, i aks mor im and ffor o sabiliz h conom (low crdibili), and; (ii) dvlopd crdibili hrfor h ask of monar polic bcoms asir and wih lss coss for h soci (high crdibili). 4.. Invsmn, consumpion, and quilibrium Th modl of aggrga dmand is basd on Fazzari, Frri and Grnbrg (008). In his sns, h basic invsmn funcion is givn b I η 0 η E η = E CF 3r E ( p ) η, () [ ( ) ] [ ( )] whr: I rprsns h ral lvl of invsmn ha is ralizd a h nd of priod. Th rm η 0 can b inrprd as rplacmn invsmn, assuming gomric dprciaion and a consan capial-oupu raio (wih a dprciaion ra of υ and a capial-oupu raio ofϕ, and η0 = υϕ ). Th rm η E ( ) ] follows from h acclraor [ modl, whr h acclraor rlas h ral lvl of invsmn o h xpcd chang in ral oupu bwn priod and - concrning informaion a -. Th rm η [ ( ) ] ( ) E CF E p rprsns h influnc of xpcd nominal cash flow, ha is, h xpcd availabili of inrnal rsourc, for h invsmns; h xpcd nominal cash flow E ) is dflad b h xpcd pric lvl E ) o ( CF ( p corrspond o ral invsmn. 6 Th rm ( η r 3 ) follows from h radiional rlaion bwn ral inrs ra and invsmn. 7 Considring E ( ) g = as h xpcd conomic growh ra bwn priod - and, hus quaion () can b rwrin as, I η 0 η g η = E CF 3r E ( p ) η. (3) [ ( )] I is imporan o no ha h xpcd nominal cash flow rsuls from h 6 As Fazzari, Frri and Grnbrg (008, p. 559) poind ou: Grar cash flow raiss h amoun of invsmns ha firms can undrak wihou incurring h risks and coss associad wih db or nw shar issus. 7 I is imporan o srss ha diffrn from h cas which h inrs ra affcs h oupu wih a lag, h acual inrs ra is rlvan for currn invsmn dcisions.

12 diffrnc bwn h xpcd nominal rvnu [ E ( p ) E ( ) ] and h xpcd wag bill [ E ( W ) ] addd o h xpcd nominal inrs coss [ E ( R ) D ], hn,8 E ( CF ) = E ( p ) E ( ) E ( W ) E ( R ) D. (4) Assuming a consan wag shar in xpcd nominal aggrga incom dnod b w, his implis ha E ( W ) = w[ E ( p ) E ( )], and hus h quaion abov corrsponds o, 9 E ( CF ) = ( w)[ E ( p ) E ( )] E ( R ) D. (5) Making h subsiuion of (5) ino (3), h invsmn funcion bcoms, D (6) I η 0 η g η ( w) E ( ) η = E ( R ) 3r E ( p ) η. Rwriing h invsmn funcion in an innsiv form, hn I E ( ) D (7) i = = η0 ηg η( w) ηe ( R ) η3r.. Y E ( p ) E ( ) Du o h fac ha, = ( g ) and = ( g ), quaion (7) bcoms D (8) i η η 0 g η ( w)( g )( g ) η = E ( R ) 3r E ( p ) η. incom, hn Assuming h raio of bginning of priod nominal db o laggd nominal D D d = and, consqunl, d =. As a consqunc, h p p invsmn quaion in is innsiv form ma b wrin as (9) i = η0 ηg η( w)( g )( g ) ηe ( R ) d η3r E ( p ) p p i = η0 ηg η µ ( g ) ηe ( R ) d η3r, E ( p ) whr i is assumd ha µ = w and = ( g ). Basd on quaion (9), whil an incras in xpcd growh ra conribus o an incras in invsmn, an incras in ral inrs ra rducs i. Th rms bwn 8 Whr ( D ) is h prdrmind nominal sock of db ousanding a h bginning of priod, ha is, D = D ( r ) p I CF. 9 This assumpion, according o Fazzari, Frri and Grnbrg (008), is consisn wih a fixd mark-up modl of pricing ha ariss from monopolisic compiion.

13 bracks dsrv h following obsrvaions: (i) Sinc D = and, D = D ( R ) p I CF, hn, d is known in priod and d p affcs invsmns invrsl in his priod; (ii) Whn g raiss, invsmns incras, and whn incrass, d dcrass; p (iii) Wih rspc o h raio, i is assumd ha whn E ( p ) incrass, p E ( p ) raiss b a largr proporion, and hn invsmns rduc. I happns bcaus, basd on highr xpcaions abou fuur prics, h priva scor sars a dfnsiv procss in rgards o prsn incom b raising is prics, which lads o a gnralizd incras of currn prics, and hn of p in a highr proporion han E ). This siuaion ( p cras uncrainis in h conom which caus invsmn rducions. In addiion, whn p sars o incras (lading o an acclraion of h inflaion ra) h public cras xpcaions for a highr ral inrs ra bcaus i knows ha h monar auhori will rac (raising h nominal inrs ra) agains h inflaionar procss, as wll as agains h drioraion of inflaion xpcaions, if boh hran h inflaion arg; hnc, E ) will also incras. ( R In ordr o xprss h muliplir ffc, a simpl consumpion funcion, whr aggrga disposabl incom ( ψ ) xplains aggrga consumpion xpndiurs, is prsnd. In his funcion C 0 rprsns h auonomous consumpion and C h avrag marginal propnsi o consum, hnc: (0) C = C ( ) 0 C ψ, whr, C 0 >0, 0 < C <, and 0 <ψ <. b, 0 I is considrd ha oupu is drmind b dmand and h quilibrium is givn () = C I A. Subsiuing (0) ino () and dividing h rsul b laggd oupu, hn C 0 C ( ψ ) () g = = i a. Making h subsiuion of quaion (9) ino (), h rsul is givn b 0 A rprsns h sum of govrnmn xpndiurs (G) wih n forign xpndiurs (X-M) and hus A = G X M. For is urn, a = A, c0 = C0, and i is assumd ha n forign incom is zro. 3

14 p η µ ( g ) η E ( R ) d C Cψ (3) = ( η0 η g a c0 η3r ) E ( p ) = p η µ ( g ) η E ( R ) d ( ψ ) C E ( p ) whr β = a c0. ( η0 ηg β η3r ) Equaion (3) rprsns h IS curv in h modl. Th main causs of changs in h muliplir (h raio bwn bracks) ar: (i) h firs rm is [ η µ ( g ) ] whr an incras (dcras) in h xpcaion of fuur conomic growh ( g ) implis an incras (dcras) in h muliplir; (ii) h scond rm η E ( R ) d p E ( p ) indicas ha whn h pric xpcaion is lowr han h xpcaion concrning h nominal inrs ra, h rsul is an incras in h xpcaion of h ral inrs ra which in urn implis an incras in h db srvic of firms, and hn, a dcras in h muliplir; (iii) h hird rm [ ( ψ ) C ] mans ha an incras (dcras) in h marginal propnsi o consum or a dcras (incras) in axaion (ψ ) amplifis (rducs) h muliplir. I mus b highlighd ha hs causs drmin h slop of h IS curv. Du o h rlvanc of crdibili in h managmn of h monar polic, xpcaions prform a crucial rol in h modl. Furhr, xpcaions ar fundamnal in h dcision-making procss of invsmn. Undr his nvironmn govrnmn announcmns rgarding public invsmns ar capabl of affcing xpcaions (for xampl, xpcd conomic growh ra). Thrfor, among h variabls of quaion (3), g bcoms fundamnal for xplaining shifs of h IS curv. Assuming ha h govrnmn announcs ha will mak nw infrasrucur invsmns, posiiv public s xpcaion rgarding a susainabl conomic growh is a consqunc (maning ha g, g > 0 ). Basd on quaion (3) whnvr g incrass hr xiss an incras in priva invsmn (I ). This incras in aggrga invsmn I is assumd ha h ffc causd b h xpcd inrs ra on h ral inrs ra is dirc. 4

15 implis dmand and produciv capaci ffcs, affcing boh oupu and inflaion. 4.. Dmand shocks, crdibili, and growh Assuming a posiiv shock on boh g and g causd b govrnmn announcmns of nw infrasrucur invsmn, h IS curv shifs for h righ and bcoms flar promoing an incras in h aggrga dmand. Thrfor h conom movs from poin A o poin B (s figur ). As a consqunc of h dmand ffc an inflaionar prssur is crad (oupu Y is grar han h original ponial oupu Y 0 ), which will impl a cnral bank racion incrasing h inrs ra in ordr o miiga his prssur. I mus b nod ha h magniud of h cnral bank rspons dpnds on h lvl of is crdibili (s schm ). Figur Effcs of crdibili on IS-MP modl r MP Low r Low r High r 0 C Low A C High MP High B IS IS 0 Y 0 Y Low Y Y High Y I is imporan o highligh ha in conras wih h parn modls concrning h subjc, his modl considrs ha h crowding ou ffc is parial. Th jusificaion is ha h capaci ffc promos an incras in h ponial oupu (givn b rgarding MP High, and Y High Y Low rgarding MP Low ) which drmins h nw inrs ra of 5

16 quilibrium ( r High or r Low, rspcivl). Hnc, hough h nw quilibrium prsns a highr inrs ra, an conomic growh is obsrvd. I mus b srssd ha h quilibrium can b changd du o diffrn lvls of crdibili (high and low drmining poins CHigh and C Low ). According o schm, cnral bank s rsponss hrough inrs ra ar lss aggrssiv whn crdibili is high (which mans a flar MP curv MP High bcaus h paramr τ is lowr). Thrfor, hrough quaion (3), if rsponss hrough inrs ra ar wakr, h impacs on oupu will b lowr. I also suggss ha boh monar polic and oupu ar bcoming lss volail. As a consqunc, basd on h analsis rgarding h influnc of crdibili for h opimal monar polic, as wll as on quaion (3) which modls h oupu bhavior, i is possibl o argu in favor of h imporanc xrd b crdibili for h oupu growh. 5. Conclusion This sud prsnd a horical analsis rgarding h ffcs of crdibili on h opimal monar polic. Th findings indica ha whn crdibili is high (low) h public is inclind o bhav forward-looking (backward-looking). Concrning inflaion arging srag, a forward-looking bhavior suggss ha inflaion xpcaions ar mor anchord o h inflaion arg maning ha h srag is srving is nds. In h cas of high crdibili, inflaion xpcaions ar mor rlvan han currn and pas inflaion for h cnral bank s racion. As a consqunc, wihou abandoning h focus on pric sabili, h monar polic is lss igh han in h cas of low crdibili and hus h impac on h oupu is anuad. Hnc, whn crdibili is highr, boh inrs ra and oupu ar lss volail. This analsis also approachs h magniud of h impacs of fiscal policis (announcmns) on h conom aking ino accoun h crdibili of h monar polic. Undr his viw, a high crdibili implis a low crowding ou ffc, which in urn conribus o a mor fficin fiscal polic (lss loss in h oupu du o an incras in h inrs ra). 6. Rfrncs BANK OF ENGLAND (999) Th ransmission of monar polic. 6

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