Inflation Band Targeting and Optimal Inflation Contracts

Abstract

In this paper we provide a theoretical treatment of how inflation target ranges cope with the time-inconsistency problem arising from incentives for the monetary policymaker to exploit the short-run trade-off between employment and inflation to pursue short-run employment objectives, as in a Barro-Gordon (1983) model. Inflation band targets are able to achieve many of the benefits that arise under practically less attractive solutions such as the conservative central banker and optimal inflation contracts. Our theoretical model also shows how an inflation targeting range should be set and how it should respond to changes in the nature of shocks to the economy. Copyright (c) 2008 The Ohio State University.

Imperfect transparency and shifts in the central bank's output gap target

“…14 In the monetary policy literature, it is quite common to allow for differences between the objective function of the central bank and the social welfare function (e.g., Barro and Gordon, 1983;Rogoff, 1985;Walsh, 1995;Svensson, 1997;Mishkin and Westelius, 2008). 15 See Geraats (2007, Section 3).…”

Inflation Targeting and Monetary Policy Activism

“…Announcement of a numerical target of inflation is often associated with the corresponding target However, with a few exceptions such as Mishkin and Westelius (2006), the roles of a target range have not been paid much attention in the existing literature (e.g., Svensson (1999Svensson ( , 2000 and Svensson and Woodford (2005)). In this section, we develop a formal theoretical model within the New Keynesian framework and derive the optimal interest rate rules with a target range.…”

Grand corruption instead of commitment? Reconsidering time-inconsistency of monetary policy

“…Other commitment devices are central banker contracts -suggested by Persson and Tabellini (1993) and Walsh (1995) -and inflation targets -suggested by Svensson (1997) and discussed by Beetsma and Jensen (1999). Mishkin and Westelius (2008) show that optimally determined inflation band targets can achieve almost optimal monetary policy while being more realistic than writing optimal inflation contracts and appointing a "conservative" central banker. Pegging the exchange rate is yet another commitment device.…”