Inflation Targeting, Announcements, and Imperfect Credibility

In virtually all theoretical studies of inflation targeting, the announced inflation target is treated as being fully credible. However, inflation targeting policies have typically been implemented after protracted periods of poor inflation performance when the policy authority's credibility is quite low. Because credibility imperfections may have a significant impact on inflation expectations and therefore on the monetary transmission mechanism, policies that are optimal under full credibility may not yield the best outcomes under imperfect credibility. In this article I use a simple dynamic model to study the implications that credibility imperfections have for the formulation of optimal inflation targeting policies.