... below, then the government incentive to cheat leads to a movement from point A to B so that the government can benefit from higher inflation (with higher monetary growth). The benefit can be seen from the fact that the government is now on a higher indifference curve since it has temporarily boosted the economy to achieve a rise in its popularity (specific at the point of reneging equilibrium B). Government indifference curves and time inconsistency But since rational wage and price setters, and wish to maximise their own benefits, their realise that when the government announces its inflation target, this is false. Therefore, their expectation is a point such that the government has no incentive to cheat (the point C). This dynamic inconsistency in government plans (due to the incentive to cheat) validates expectations and leads to the time consistent discretionary equilibrium at point C, despite the fact that the other Nash ...

See this essay or coursework document in full right now