On the fragility of reputational equilibria under systematic uncertainty: what is wrong with rational expectation

Abstract

The present work examines the case in which the imperfect monitoring of policy does not derive from the existence of some informational asymmetry, but rather directly from a limited monitoring ability of economic agents in a framework that is closest in its essence to that of complete information. This shows that imperfections in the individual monitoring abilities destroy the very possibility of a reputational equilibria. Thus, the existing literature on credibility and reputation does not provide a convincing explanation of the existence of reputational effects in the real world policy game. The author argues that the use of rational expectations models in policy analysis is even less motivated than their use as a rigorous theoretical description of the working of the economic system. As a consequence, a major change in the analytical framework is required to achieve a sensible model of reputational forces in the conduct of monetary policy. JEL: D82, E52

Keywords

• Reputational equilibria
• Informational asymmetry
• Individual monitoring
• Monetary policy