Dealing With Deflation Bias Through a Dismissal Contract
I study the use of a dismissal contract to reduce deflation bias caused by the existence of the zero-lower bound. It is found that a dismissal contract which states that the central banker will be fired if inflation is lower than a critical value is able to reduce deflation bias, in both states in which the zero-lower bound is binding and states in which the zero-lower bound is not binding. This critical value should reduce as the output gap increases, in order to incentivize the central banker to prioritize reducing deflation. Furthermore, it is confirmed that inflation expectations are the mechanism through which the zero lower bound constraint affects output and inflation even in states of the economy in which the zero-lower bound is not binding. Imposing a zero-lower bound on inflation expectations removes the effect of the zero-lower bound constraint on output and inflation in states of the economy in which the zero-lower bound constraint is not binding.
Faculteit der Managementwetenschappen