Mechanisms for Achieving Monetary Stability : Inflation Targeting Versus the Erm

First, we modify the Barro-Gordon model so that a credibility-stabilization tradeoff will remain, even when a performance contract of the type envisaged by Walsh (1995) is imposed on the central bank governor. We do this by modeling a real interest rate bias along with the inflation bias. Then, we discuss how various inflation penalties might actually be imposed on a central bank, and ask whether "inflation targeting" supported by one or another of the penalties) is likely to bring a better resolution to the credibility-stabilization tradeoff than the ERM