In a monetary game played by the private sector and a central banks (CB), who has private information, reputation may not completely solve the CB time inconsistency problem. An alternative solution is CB Conservativeness. The optimal degree of CB Conservativeness is solved in both the reputational and non-reputational regime and reputation is proved to be substitute for conservativeness. Unless reputation works perfectly, the public can always gain from a conservative CB. Our model offers a unified framework to analyze both CB reputation and conservativeness. Our result can explain why low-reputation CBs find it worthwhile to peg the exchange rate to the currency of a high-reputation CB and why a highly reputable CB, like the Bundesbank, can afford to miss monetary targets more often than a less reputable CB.
Publication Date
Financial Markets Group Discussion Papers DP 216
