Inflation targeting in a Post Keynesian economy

Abstract

Lima and Setterfield (2008) showed that it is possible to make inflation targeting compatible with an essentially Post Keynesian economy, yet they considered the process of expectations formation with exogenous credibility. This work reconstructs all of the Lima and Setterfield models, considering an endogenous process for explaining credibility. The results confirm that the combinations of Post Keynesian policies have a large capacity to lead the economy toward the desired levels of output and inflation, while orthodox policies are generally incompatible with the Post Keynesian environment. A novel finding is that convergence for the output and inflation targets also means that maximum credibility is obtained and that appropriate policies avoid systematic forecasting errors, which cause a crisis of confidence.

Keywords:

• incomes policy
• inflation targeting
• monetary policy
• Post Keynesian economics