The Signaling Effect of Raising Inflation

Jean Barthélemy (1, 2) , Eric Mengus (3)

1 Centre de recherche de la Banque de France
2 ECON - Département d'économie (Sciences Po)
3 HEC Paris - Recherche - Hors Laboratoire

This paper argues that central bankers should raise inflation when anticipating liquidity traps to signal their credibility to forward guidance policies. As stable inflation in normal times either stems from central banker's credibility, e.g. through reputation, or from his aversion to inflation, the private sector is unable to infer the central banker's type from observing stable inflation, jeopardizing the efficiency of forward guidance policy. We show that this signaling motive can justify level of inflation well above 2% but also that the low inflation volatility during the Great Moderation was insufficient to ensure fully efficient forward guidance when needed.

Keywords: Forward guidance; Inflation; Signaling

Domains: Economics and Finance

Jean Barthélemy, Eric Mengus. The Signaling Effect of Raising Inflation. 2016. ⟨hal-03471880⟩