CAN REPUTATION RESOLVE THE MONETARY-POLICY CREDIBILITY PROBLEM

This paper addresses three problems with 'reputational' equilibria in the Barro-Gordon monetary policy game: the multiplicity of equilibria, the coordination problem, and a 'chisel-prone' credibility problem. A 'chisel-proof' credibility condition 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. If the private sector can coordinate, then a low but nonzero inflation outcome can be supported as a subgame-perfect and 'chisel-proof' credible noncooperative equilibrium. For an atomistic private sector the result can still hold in a game between successive monetary administrations.