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

We study the implications of uncertainty for ination targeting. We apply Brainard's static framework which imposes multiplicative uncertainty in the monetary transmission. Brainard's main result is that in the presence of uncertainty, monetary authorities become naturally more cautious. But this also implies that monetary objectives are seldom achieved. We there- fore attempt next to ...nd a monetary rule that reaches the objectives set more often, improving therefore the welfare of the Central Bank. Such a rule is the result of a new algorithm that we put forward, in which the ination target is state contigent. The Central Bank sets (as an auxil- liary step) therefore, a variable ination target that depends optimally, on both the degree of uncertainty as well as on the shocks that occur each time. We show that such a rule helps the CB attain its objectives more often thereby reducing the losses incurred. Moreover, and as a corollary to such an approach, the rule derived is ex ante neutral to the degree of uncertainty.