Imperfect credibility, sticky wages, and welfare

This paper studies optimal monetary policy under imperfect credibility in a New Keynesian model with staggered price and wage setting. In our framework, the central bank commits to plan but occasionally reneges on past promises given common knowledge probability. We find that welfare gains from increasing are approximately linear initial level. also output-inflation stabilisation trade-off is nonmonotonic as higher does not always reduce output volatility. The variance decomposition shows markup shocks main driver of economic fluctuations these better contained, even relative terms, when high. then show degree impacts effect flexibility welfare. When low, less potent economy can experience feedback loop between volatility show, though, once taken into account, usually improving.