This paper is an outgrowth of a paper titled “Reconsideration of Inflation Targeting in Korea” (in Korean). An early draft of this paper has been presented at the Bank of Korea, the Korea Money and Finance Association annual meeting and Kyunghee University. The author thanks Hyun Eui Kim, Kyuil Chung, Byoung Hark Yoo, Seokwon Kim, Hyoung-seok Lim, Seonghoon Cho, Hyun Park, Yong Seung Jung, and other seminar participants for helpful discussions and comments on the early draft of the paper. Any remaining errors are mine. The views expressed herein are those of the author and do not necessarily reflect the official views of the Bank of Korea.
Inflation Targeting as Constrained Discretion
Article first published online: 27 SEP 2011
© 2011 The Ohio State University
Journal of Money, Credit and Banking
Volume 43, Issue 7, pages 1505–1522, October 2011
How to Cite
KIM, J. (2011), Inflation Targeting as Constrained Discretion. Journal of Money, Credit and Banking, 43: 1505–1522. doi: 10.1111/j.1538-4616.2011.00433.x
- Issue published online: 27 SEP 2011
- Article first published online: 27 SEP 2011
- Received January 20, 2009; and Accepted March 17, 2011.
- monetary policy;
- inflation targeting;
- constrained discretion;
- medium term;
- optimal horizon
This paper suggests a simple framework for modeling inflation targeting as constrained discretion. Although it is widely claimed that inflation targeting has been successful in maintaining low and stable inflation, an announcement of an inflation target does not by itself mean that central bankers are precommiting to how they conduct monetary policy. In comparison to the assumption of many theoretical studies, central banks conduct monetary policy in a discretionary fashion and rarely precommit to a rule in reality. Therefore, the central bank in this paper is modeled as discretionary, yet faced with a constraint, that an average of future inflation over a certain horizon should be kept on or near the preannounced target level. It is natural to add this constraint to the central banker’s optimization problem, since inflation targeting involves one way or another an evaluation of the performance over a certain horizon. So it is argued that the better outcome of inflation targeting does not come from a commitment but from “constrained discretion.” This paper also sheds some light on optimal targeting horizon.