Market discipline and monetary policy

The effects of forward looking expectations of future inflation on equilibrium inflation and interest rates are examined within an imperfect information framework. Expectations of future inflation affect equilibrium in a manner similar to an increase in the central bank's weight on future social welfare, making it more likely an opportunistic central bank will actually deliver on its announced inflation targets, and output expansions can arise even if the central banker is revealed to be a low inflation type. The model also illustrates the channels through which inflation scares raise current real interest rates.