Endogenous Time-Dependent Rules and the Costs of Disinflation with Imperfect Credibility

The real effects of an imperfectly credible disinflation depend critically on the extent of price rigidity. Therefore, the study of how the policymaker's credibility affects the outcome of an announced disinflation should not be dissociated from the analysis of the determinants of the frequency of price adjustments. In this paper we examine the output effects of an imperfectly credible monetary disinflation in a model with endogenous time-dependent pricing rules. We take as the base case a disinflation policy with a constant degree of credibility, and show that the interaction between the endogeneity of time-dependent rules and imperfect credibility increases the output costs of disinflation. We also study the case in which the monetary authority gains credibility during the disinflation as agents update their beliefs.