In°ation Target Instability and Interest Rates

The implementation of explicit quantitative in°ation targets elucidates the assessment of credibility of future monetary policy. Here the explicit in°ation target is time-varying and stochastic with asymmetric information. It is shown that central bank independence promotes lower in°ation but not at the cost of increased output variability. Marked political instability and instrument dependence are detrimental to credibility. The marginal e®ect from less instrument independence on interest rate volatility is increasing in political instability. Strategic delegation of an optimal in°ation target with a monetary reform eliminates the in°ation bias. Empirical evidence substantiates the predictions when confronted with cross-country OECD data.