SIGNALING AND COMMITMENT: MONETARY VERSUS INFLATION TARGETING

Abstract

The article compares the social efficiency of monetary targeting and inflation targeting when central banks may have private information on shocks to money demand and the transparency solution is not feasible because of verifiability problems. Under inflation targeting and monetary targeting, central banks may have an incentive to signal their private information in order to influence the public's expectations about future inflation. We show that inflation targeting is superior to monetary targeting, as it makes it easier for central banks to commit to low inflation. Moreover, central banks that are weak on inflation prefer inflation targeting to monetary targeting.