Optimal Inflation Target Under Uncertainty
Posted: 25 Dec 2004
We derive an optimal state-contingent inflation target in an economy under uncertainty. This inflation target can improve inefficiencies stemming from two sources: the lack of commitment to predetermined policies and the lack of coordination between the monetary and fiscal authorities. We then discuss the pros and cons of our proposal compared with the solution proposed by Beetsma and Bovenberg [Beetsma, R.M.W.J., Bovenberg, A.L., 2001]. When does an inflation target yield the second best? Scandinavian Journal of Economics 103, 119-126], paying special attention to their practical feasibility. We will show that in some countries where there is a highly independent central bank, our proposal is more attractive.
Keywords: Inflation targeting, Uncertainty, Conservativeness, Policy coordination, Time inconsistency problem
JEL Classification: E50, H60
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