Credibility of Economic Policy

Reputation

Governments and states, like persons, acquire reputations that affect judgments about their likely behavior. Economic policy can change in response to new insights, new experiences, and new goals. However, a reputation for pursuing one type of economic policy can be a significant obstacle to establishing the credibility of a new type of policy. People often suspect that the heavy hand of history will reverse a new policy initiative in a government with a long-established reputation for pursuing a contrary policy. These public beliefs may have significant adverse economic consequences.

Consider, for example, tax policy. A reputation for arbitrary and confiscatory tax policy discourages business development while a reputation for consistent and equitable taxes fosters business development. The effect of reputation is that a promise in a particular case is measured against past behavior. Thus a government with a reputation for arbitrary and confiscatory tax policy will have difficulty fostering a particular investment with a promise to apply taxes to that investment in a fair and consistent way.

Several factors are important for overcoming one reputation and establishing a different one. First, a package of significant policy changes, as long as they are compatible and sustainable over time, is likely to provide a clearer and more convincing indication of a new policy direction than smaller, incremental changes. Second, a clearly articulated and consistently expressed public description of the new policy fosters its credibility. Providing information so that persons outside the government can monitor and evaluate the policy change re-enforces the credibility of the public message. Finally, establishing a new reputation takes time. Institutional structures that orient government policy incentives toward the long-term benefits of the policy shift make that policy shift more credible.

Policy Credibility Learning Module