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Dealing with Time Inconsistency: Inflation Targeting versus Exchange Rate Targeting

Jonathan Davis (), Ippei Fujiwara and Jiao Wang

Journal of Money, Credit and Banking, 2018, vol. 50, issue 7, 1369-1399

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).

Date: 2018
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Handle: RePEc:wly:jmoncb:v:50:y:2018:i:7:p:1369-1399