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A Theory of Dynamic Inflation Targets

Author

Listed:
  • Christopher Clayton
  • Andreas Schaab

Abstract

Should central banks' inflation targets remain set in stone? We study a dynamic mechanism design problem between a government and a central bank. The central bank has persistent private information about structural shocks. Firms learn the state from the central bank's reports and form inflation expectations. A dynamic inflation target implements the full-information commitment allocation. The central bank is delegated the authority to adjust the target's level and flexibility one period in advance. A declining natural interest rate and a flattening Phillips curve imply opposite optimal target adjustments. Our results speak to practical policy questions of inflation target design.

Suggested Citation

  • Christopher Clayton & Andreas Schaab, 2025. "A Theory of Dynamic Inflation Targets," American Economic Review, American Economic Association, vol. 115(2), pages 448-490, February.
    • Handle: RePEc:aea:aecrev:v:115:y:2025:i:2:p:448-90
    DOI: 10.1257/aer.20230496
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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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