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Dealing with Time Inconsistency: Inflation Targeting versus Exchange Rate Targeting
Author(s) -
DAVIS J. SCOTT,
FUJIWARA IPPEI,
WANG JIAO
Publication year - 2018
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/jmcb.12551
Subject(s) - openness to experience , exchange rate , credibility , economics , inflation targeting , inflation (cosmology) , monetary economics , mandate , monetary policy , open economy , exchange rate flexibility , exchange rate regime , psychology , social psychology , physics , theoretical physics , political science , law
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).