Inflation Band Targeting and Optimal Inflation Contracts

Frederic S. Mishkin · Niklas Johan Westelius

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Monetary Policy and Economic Impact Economic Theory and Policy Economic theories and models

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.

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References

1977Rules Rather than Discretion: The Inconsistency of Optimal Plans 1999The Science of Monetary Policy: A New Keynesian Perspective 1985The Optimal Degree of Commitment to an Intermediate Monetary Target 1983A Positive Theory of Monetary Policy in a Natural Rate Model 1981A Positive Theory of Monetary Policy in a Natural-Rate Model 1993Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence 1992Central Bank Strategy, Credibility, and Independence: Theory and Evidence 1999Inflation targeting: lessons from the international experience

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