Inflation Announcements and Social Dynamics
We investigate the effectiveness of central bank communication when firms have heterogeneous inflation expectations that are updated through social dynamics. The bank's credibility evolves with these dynamics and determines how well its announcements anchor expectations. We find that trying to eliminate high inflation by abruptly introducing low inflation targets generates short-term overshooting. Gradual targets, in contrast, achieve a smoother disinflation. We present empirical evidence to support these predictions. Gradualism is not equally effective in other situations though: our model predicts aggressive announcements are more powerful when combating deflation.
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Document Object Identifier (DOI): 10.3386/w20161