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

Ippei Fujiwara and Jonathan Davis

No 795, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: Abandoning an objective function with multiple targets and adopting a single mandate is an effective way for a central bank to overcome the classic time-inconsistency problem. We show that the choice of a particular single mandate depends on a country's level of trade openness. Both inflation targeting and nominal exchange rate targeting come with their own costs. We show that the costs of inflation targeting are increasing in a country's level of trade openness while the costs of exchange rate targeting are decreasing in trade openness. Thus a relatively closed economy will prefer an inflation targeting mandate and a very open economy will prefer an exchange rate target. Empirical results show that as central banks become less credible they are more likely to adopt a pegged exchange rate, and crucially the empirical link between central bank credibility and the tendency to peg depends on trade openness.

Date: 2017
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
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Related works:
Working Paper: Dealing with Time-Inconsistency: Inflation Targeting vs. Exchange Rate Targeting (2018)
Working Paper: Dealing with Time-Inconsistency: Inflation Targeting vs. Exchange Rate Targeting (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:795

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