A note on imperfect credibility

Abstract

We explore how outcomes of optimal monetary policy with loose commitment (Schaumburg and Tambalotti, 2007||Debortoli and Nunes, 2010) can be observationally equivalent, or interpretable as outcomes of deeper optimal policy under sustainable plans (Chari and Kehoe, 1990). Both interpretations of ?imperfect credibility ? in optimal monetary policy design are attempts to rationalize outcomes that lie in between the conventional extremes of optimal policy under commitment and under discretion. In a standard monetary-policy framework, when we match impulse responses of inflation and the output gap to large enough markup shocks, we find that a small probability (1 - a = 0.05) of replanning in the quasi/loose commitment world corresponds to N = 18 in the N-period punishment optimal sustainable monetary policy, in terms of observable outcomes. For plausible cases of loose-commitment model economies (with a between 0.77 and 1) we can find an observationally equivalent sustainable-plan economy indexed by some N. Show more