Does monetary policy credibility mitigate the effects of uncertainty about exchange rate on uncertainties about both inflation and interest rate?

Abstract

In the present paper, we investigate the effects of the disagreement in expectations about exchange rate on the disagreements in expectations about inflation and about monetary policy interest rate in Brazil. The analysis seeks to verify whether the uncertainty related to the future behavior of the exchange rate affects both the process of inflation expectation formation and the process of monetary policy interest rate expectation formation. Besides, the paper investigates the role of monetary policy credibility in mitigating the effects of the disagreement in expectations about exchange rate on the disagreements in expectations about inflation and about monetary policy interest rate. The results indicate that the disagreement in expectations about exchange rate impacts the disagreements in expectations about both inflation and monetary policy interest rate. In addition, the findings indicate that credibility is capable of mitigating the transmission of uncertainties about the exchange rate to uncertainties about the inflation rate and the monetary policy interest rate. Thus, our estimates reveal that (i) the marginal effect of disagreement in expectations about exchange rate on the disagreement in expectations about inflation decreases with the level of credibility and, (ii) the marginal effect of disagreement in expectations about exchange rate on the disagreement in expectations about monetary policy interest rate decreases as credibility increases.