Aiming for the Bull's Eye: Inflation Targeting under Uncertainty

We study inflation targeting under uncertainty. Although uncertainty in the values of structural parameters makes the policy maker naturally more cautious, it does not immediately lead to the optimal monetary policy rule. We examine thus whether there exists a policy rule that improves welfare and discover that having a state contingent inflation target is more likely to improve the performance of the system. This occurs because the instrument is not constrained by the degree of uncertainty of the system which outweighs the losses from an increase in discretion in monetary policy.