Abstract
This paper develops a game-theoretic model of inflation under noisy observation to examine how monetary policy transparency and public scepticism affect inflation outcomes. A government sets the inflation rate while anticipating a representative agent's price adjustments. The agent observes inflation with noise and incurs menu costs. Scepticism is modelled as the variance in the agent's prior belief about the government's inflationary preferences, while transparency is inversely related to the noise variance. In a perfect Bayesian equilibrium, greater scepticism leads agents to rely more on observations, aggressively adjust prices, and reduce inflation by discouraging surprises. Reduced transparency increases reliance on priors, weakening adjustments and enabling higher and more volatile inflation. Lower menu costs enhance flexibility, further constraining inflation. The findings show that scepticism and transparency interact to discipline inflation, with their effect amplified by low menu costs. Institutional reforms that boost transparency and flexibility can therefore mitigate inflationary bias and formally link democracy and lower inflation.