Rational Expectations and Policy Credibility Following a Regime Change

We examine the economy after a regime change, when neither the policy nor the reactions of the public are known. This is an application of Kreps and Wilson's reputation model to Barro and Gordon's macroeconomic policy game. Equilibrium is defined as the dynamically consistent solution to a game between the government and the private sector. It involves mixed strategies and Bayesian learning on both sides. The absence of complete credibility and intransigence of private sector wage demands increase the output loss of disinflation.