Dealing with Time-Inconsistency: Inflation Targeting vs. Exchange Rate Targeting

• DOI: 10.2139/ssrn.3141598
• Publication Date: 2018-03-22T21:53:17Z
• Authors: J. Scott Davis; Ippei Fujiwara; Jiao Wang
• Keywords: Exchange rate peg; Tie-one’s-hands; 330; Commitment; 0502 economics and business; 05 social sciences; 8. Economic growth; Time-inconsistency; 332; Inflation target

Abandoning an objective function with multiple targets and adopting a single mandate can be effective way for central bank to overcome the classic time-inconsistency problem. We show that choice of particular depends on economy’s level trade openness credibility bank. begin reduced form empirical results which as banks become less credible they are more likely adopt pegged exchange rate, crucially, tendency peg openness. Then in model where displays “loose commitment” we falls, either inflation target or rate. A relatively closed economy would problem, but highly open prefer rate peg.