J. Bradford DeLong
When workers, firms, and investors lose confidence in a central bank's commitment to price stability, the expected inflation rate too rises. This shifts the aggregate supply curve upward.
Such a loss of credibility looks exactly like a supply shock. The central bank can (a) expand the money supply to keep the upward shift in the aggregate supply curve from causing a recession, at the cost of higher inflation; or (b) keeping the loss of confidence from generating higher inflation by raising interest rates, creating deep recession.
Neither alternative is appetizing.
So central banks jealously guard their credibility as inflation-fighters.
|The Dilemma of Stagflation|
of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
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