The importance of credibility for the conduct of monetary policy and inflation control Theoretical model and empirical analysis for Brazil under inflation targeting Gabriel Caldas Montes1* Alexandre Curi **

Abstract This paper raises the following hypotheses: to the extent that the monetary authority successively reaches the inflation target and credibility increases, expectations will have more influence on inflation and, thus, the efforts of the monetary authority to reach the inflation target will decrease. Hence, the goal of this work is twofold: 1) a theoretical model is developed to show that when the monetary authority is committed to the goal of price stability, the gain of credibility not only acts by producing a better result in terms of inflation, but also it reduces the volatility of the basic interest rate, and; 2) based on the Brazilian economy, the article provides empirical evidence that the gain of credibility is crucial to reduce the volatility of the basic interest as well as the inflation rate. The findings suggest that credibility plays a key role for the conduct of monetary policy and inflation control.

Keywords: inflation targeting, credibility, interest rate, inflation

JEL classification: E43, E52, E58

*

Fluminense Federal University, Department of Economics, National Council for Scientific and Technological Development (CNPq), Brazil. Rua Tiradentes, 17, Ingá, Niterói, Rio de Janeiro, CEP: 24210-510. gabrielmontesuff@yahoo.com.br ** Fluminense Federal University, Department of Economics, Rua Tiradentes, 17, Ingá, Niterói, Rio de Janeiro, CEP: 24210-510. alexandre.curi@yahoo.com

1. Introduction The seminal article of Kydland and Prescott (1977) served as theoretical framework for the development of studies about credibility of the monetary authority. Studies point that monetary policies will be more effective and the