PROFESSOR EISNER'S attempt to revive the liquidity takes the form of five objections to the findings reported by Bronfenbrenner and Mayer.2 In this note I will direct my discussion to the question of evidence for the trap and comment only briefly on other points which Eisner raises. The main burden of my argument is that evidence for or against the liquidity must rest on a demand function for money which explains more than the period surrounding the supposed trap. The post-1 920 data alone are inadequate to support (or reject) the hypothesis. For it has long been known that long-term bond yields peaked in the U.S. in 1920-21 and thereafter declined. A similar movement is shown by velocity. At issue are two questions: (1) whether the data for the 1930's and 1940's show a movement of two variables which are related or a co-movement of two variables each of which declined for any one of a number of other reasons,3 and (2) if the variables are related, do they show evidence of a trap?

This paper develops a positive theory of credibility, ambiguity, and inflation under discretion and asymmetric information. The monetary policymaker maximizes his own (politically motivated) objective function that is positively related to economic stimulation through monetary surprises and negatively related to monetary growth. The relative importance he assigns to each target shifts stochastically through time. His current preference trade-off is known to him but not to the public. When choosing the (state contingent) path of money growth for the present and the future, the policymaker compares the benefits from current stimulation with the costs associated with higher future inflation expectations. Current monetary growth conveys information to the public about future money growth because there is persistence in the policymaker's objectives. Although expectations are rational, information is imperfect because monetary control procedures are imprecise. As a result the public cannot correctly distinguish persistent changes of emphasis on different policy objectives from transitory monetary control errors. The public becomes aware of changes gradually by.observing past monetary growth. Credibility is defined in terms of the speed with which the public recognizes changes in the objectives of the policymaker. Credibility is lower the noisier monetary control and the more stable the objectives of the policymaker. Looser monetary control and a higher degree of time preference on the part of the policymaker induce him to produce higher and more variable monetary growth. When the policymaker is free to determine the accuracy of monetary control he does not always choose the most effective control available in spite of the fact that monetary surprises always have an expected value of zero. The reason is that ambiguous control procedures enable the policymaker to generate positive surprises when he cares more than on average about economic stimulation. He leaves the inevitable negative surprises for periods in which he cares more about inflation prevention. This result provides an explanation for the Fed's preference for ambiguity, recently documented by Goodfriend (1986). The policymaker is more likely to pick more ambiguous control procedures the more uncertain his objectives and the higher his time preference. The paper also provides a theoretical underpinning for the well documented crosscountry positive correlation between the level and the variability of inflation.