REPUTATIONAL CONSTRAINT AND SIGNALLING EFFECTS IN A MONETARY POLICY GAME

Reputational effect in a dynamic monetary policy game is analyzed using a simple linear-quadratic model with finite duration. The standard Barro-Gordon (1983) model is extended by: 1. considering a continuum of types of policymakers, and 2. introducing the disturbances to the economy and the control errors in money supply that generates imperfect monitoring of the public. The monetary policy game is considered in a 2-period setting. A sequential equilibrium of this monetary policy game is derived. It is found that: 1. the equilibrium does not involve mixed strategies and is characterized not by trigger-type discontinuous strategies, but by continuous strategies, and 2. every type of policymaker sets a lower inflation rate in the first stage than the rate that is selected if the game is one shot. The reputational effect constrains the policymaker since the performance of the policymaker in the early stage of the game serves as a signal to the public who infer the policymaker's character.