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Optimality, rational expectations and time inconsistency applied to inflation targeting strategy

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  • Marinas, Marius
  • Zoican, Marius Andrei

Abstract

The purpose of this paper is to analyse the characteristics of an inflation targeting strategy, using the Barro-Gordon model specific tools. This paper uses the initial Barro-Gordon concepts of inflationary social costs and benefits, adding a new dimension generated by the cost of output deviating from the potential level. The main contribution of this paper is the exhaustive study of the time inconsistency problem generated by the very existence of a policymaker-established inflation rate. The mathematic simulation of a model allowed a complete analysis of several parameters’ influence (parameters such as the optimal rate of inflation, the discount rate, the importance structure of inflationary social cost) on the applicable range of the target inflation rate, range that guarantees that the policymakers have no incentive to break their own rules, or at least this incentive is somewhat inferior to the future cost of doing so.

Suggested Citation

  • Marinas, Marius & Zoican, Marius Andrei, 2008. "Optimality, rational expectations and time inconsistency applied to inflation targeting strategy," MPRA Paper 17298, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:17298
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    References listed on IDEAS

    as
    1. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
    2. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, April.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Rasekhi, Saeed & Rastgar, Majid, 2016. "Policy Time-Inconsistency: A Comparison of Managed Floating Exchange Rate and Controlled Exchange Rate Regimes," Journal of Money and Economy, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, vol. 11(4), pages 351-373, October.

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    More about this item

    Keywords

    optimal inflation rate; inflation targeting strategies; the Barro-Gordon model; output gap; central bank credibility;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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