Bandwidth, bandlength, and inflation targeting: some observations

Central banks announce specific inflation targets to help anchor inflation expectations and to raise the level of monetary policy credibility (see Debelle and Stevens (1995)). Generally, however, it is argued that in setting inflation targets, there is a trade-off between credibility and flexibility. Targets also provide a yardstick against which the central bank’s success can be measured, allowing the monetary authority to establish a reputation as an inflation fighter. A good reputation leads to increased credibility. But the downside is that a tight inflation objective ties the central bank’s hands and leaves it less freedom in how it responds to economic shocks.