CONFIDENCE CRISES, CREDIBILITY AND THE INFLATION TARGET LEVEL

Considering the ination targeting regime, we appraise how the target level should be set in the presence of uncertainty about the commitment strength. First, based on a concise framework, where condence crises and imperfect information are neglected, we conclude that a higher target for ination increases the credibility in the precommitment. Optimal target is higher than the one obtained using the Cukierman-Liviatan [5] model, where the increasing credibility effect is not considered. Second, extending the model to make condence crises possible, multiple equilibria solutions become possible too. In this case, higher targets for ination may increase the probability of above the target ination. On the other hand, multiple (bad) equilibria may be avoided. The optimal target depends on the likelihood of each equilibrium to be selected and on the policymaker's willingness to avoid a condence crisis. Finally, uniqueness is ensured when common knowledge is perturbed, even considering spec-ulative attacks, as in Morris-Shin[6]. The rst result is also recovered, i.e. a higher target for ination increases the credibility in the precommitment. Adding a precise public signal, self-fullling actions and equilibrium multiplicity may still exist for some lack of common knowledge (as in Angeletos and Werning[1]). In this case, higher targets for ination may increase the prob-ability of above the target ination again, reducing the policymaker's credibility. From another aspect, multiple (bad) equilibria may be avoided. The optimal target depends on the likelihood of each equilibrium to be selected and on the policymaker's willingness to avoid a condence crisis. Results also indicate that more precise public information may open the door to bad equilibrium, contrary to the conventional wisdom that more central bank transparency is always good when an ination targeting regime is considered. Fundação Getulio Vargas and Instituto de Matematica Pura e Aplicada. yBrazilian Central Bank (BCB)