Premium
Limited commitment, endogenous credibility and the challenges of price‐level targeting
Author(s) -
Cateau Gino,
Shukayev Malik
Publication year - 2022
Publication title -
canadian journal of economics/revue canadienne d'économique
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.773
H-Index - 69
eISSN - 1540-5982
pISSN - 0008-4085
DOI - 10.1111/caje.12617
Subject(s) - credibility , discretion , volatility (finance) , economics , monetary economics , microeconomics , path (computing) , econometrics , computer science , political science , law , programming language
This paper studies the cost of limited commitment when a central bank commits to a price‐level target path but retains the discretion to re‐optimize it whenever the cost of honouring its commitment exceeds a tolerance threshold. Such discretion undermines the credibility of the price‐level target path and weakens its effectiveness to stabilize the economy. Endogenous target resets are more costly than exogenous target re‐optimizations and can give rise to multiple equilibria, including a low credibility equilibrium with frequent target resets and high volatility. Canadian data suggest that price‐level target resets could be quite frequent in practice.