Inflation Targeting as Constrained Discretion
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 pre-announced 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.