Inflation targeting in a post keynesian economy

Abstract

Lima and Setterfield (2008) showed that it is possible to make infla-tion targeting compatible with an essentially Post Keynesian economy, yet theyconsidered the process of expectations formation with exogenous credibility.This work reconstructs all of the Lima and Setterfield models, considering anendogenous process for explaining credibility. The results confirm that the com-binations of Post Keynesian policies have a large capacity to lead the economytoward the desired levels of output and inflation, while orthodox policies aregenerally incompatible with the Post Keynesian environment. A novel finding isthat convergence for the output and inflation targets also means that maximumcredibility is obtained and that appropriate policies avoid systematic forecastingerrors, which cause a crisis of confidence.