CONTRACTS, CREDIBILITY, AND COMMON KNOWLEDGE - THEIR INFLUENCE ON INFLATION CONVERGENCE

In this paper, three possible reasons are examined for a sluggish infl ation response to a hard-currency peg. Models of overlapping wage cont racts are analyzed and shown to generate little inertia. These finding s are contrasted with the effects of government credibility and the sp eed of private sector learning, which are shown to have a major impact on the speed of inflation adjustment. But even if individual agents b elieve the government will not devalue its currency, it is shown that inflation inertia can still arise if these expectations are not common knowledge.