Inflation Targeting and Central Bank Incentives

This paper studies the incentives a central bank faces in announcing inflation targets when the central bank has private information about the economy and the public is uncertain about the central bank’s preferences. Targeting rules in the absence of announcements reduce the inflationary bias of discretionary policy, but they distort the central bank’s response to private information about the economy. This distortion is eliminated when the central bank is allowed to announce the inflation target. Announcements also affect credibility, although the way they do so depends on the exact definition of credibility that is employed.