Inflation Band Targeting and Optimal Inflation Contracts

In this paper we examine how target ranges work in the context of a Barro-Gordon (1983) type model, in which the time-inconsistency problem stems from political pressures from the government. We show that target ranges turn out to be an excellent way to cope with the time-inconsistency problem, and achieve many of the benefits that arise under practically less attractive solutions such as the conservative central banker and optimal inflation contracts. Our theoretical model also shows how an inflation targeting range should be set and how it should respond to changes in the nature of shocks to the economy.lt;brgt;lt;brgt;Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at lt;a href=quot;http://www.nber.org/papers/w12384quot; TARGET=quot;_blankquot;gt;www.nber.org.lt;/agt;lt;brgt