Optimal state-dependent rules, credibility, and inflation inertia

We use a state-dependent model where pricing rules are optimal to examine the costs of a money-based disinflation under various assumptions about the credibility of the policy change. Our analysis allows us to relate actual credibility and future inflation inertia to the asymmetry of the price deviation distribution. An important implication of our state-dependent setting is that disinflation can be attained without substantial cost even in a situation of low credibility, provided that a mechanism of price alignment eliminates the asymmetry of the price deviation distribution. We also develop an analytical framework for analyzing intermediate imperfect credibility cases. (C) 2002 Elsevier Science B.V. All rights reserved.