A Theory of Dynamic Inflation Targets

Christopher Clayton and Andreas Schaab

American Economic Review, 2025, vol. 115, issue 2, 448-90

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.

JEL-codes: D82 E12 E31 E52 E58 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1257/aer.20230496

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