Dealing with Time Inconsistency: Inflation Targeting versus Exchange Rate Targeting

J. Scott Davis, Ippei Fujiwara, Jiao Wang

Research output: Contribution to journalArticle

Abstract

Adopting a single instead of multiple targets can be an effective way to overcome the classic time-inconsistency problem. The choice of a single mandate depends on the trade openness and the credibility. Reduced-form empirical results show as central banks become less credible, they are more likely to adopt a pegged exchange rate, and the tendency to peg depends on trade openness. In a model with “loose commitment,” as credibility falls, either an inflation target or a pegged exchange rate is more likely to be adopted. A relatively closed (highly open) economy would adopt an inflation target (exchange rate peg).

Original languageEnglish
Pages (from-to)1369-1399
Number of pages31
JournalJournal of Money, Credit and Banking
Volume50
Issue number7
DOIs
Publication statusPublished - 2018 Oct 1

Keywords

  • commitment
  • E30
  • E50
  • exchange rate peg
  • F40
  • inflation target
  • tie one's hands
  • time-inconsistency

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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