Faculty of Economics and Business Administration Publications Database

Trust in the monetary authority

Bursian, Dirk
Volume: 98
Pages: 66 - 79
Month: October
ISSN-Print: 0304-3932
Link External Source: Online Version
Year: 2018
Keywords: Trust games; Betrayal aversion; Monetary transmission mechanism

Trust in policy makers fluctuates significantly over the cycle, evaporating during crises and affecting the transmission mechanism. Despite this, it is absent from the literature. We build a monetary model where trust emerges endogenously as an equilibrium of a strategic interaction (moral hazard with uncertainty on policy actions) between betrayal-averse agents and policy makers with stochastic incentives to deviate, conditioned on past policy outcomes as signals. A fall in trust, due to shocks or policy actions, increases the price that agents attach to future contingencies, amplifies fluctuations, and steepens the sacrifice ratio. We test the transmission of shocks through VAR analyses where trust is proxied by answers to the Eurobarometer surveys.