A Simple Model of Inflation Band Targeting

Abstract

The inflation targeting policy, which is adopted in a lot of countries in recent years, has been introduced with a band target in most countries. However, in the many theoretical analysis, the target of the inflation rate is assumed to be a point, and the studies that have treated the following problem, 'Why does the central bank set the band target?' are very few. In this paper, to treat the above-problem, we make the inflation band targeting model which is based on Barro and Gordon(1983) model. After defining the Credibility for the inflation targeting policy, we show the condition which the central bank adopts it, and inflation band targeting can be solved the time inconsistency problem when this condition is satisfied.Moreover, when the central bank has few information on the private agents' expectations formation of inflation, we show the criteria how they should determine the upper bound and the lower bound of a target range. This model's characterized are the following; (1) to show that the central bank can adopt the inflation band targeting without changing their objective function, (2) to consider the interaction between inflation targeting policy and the private agents' expectations formation of inflation, (3) to show the criteria how the central bank can determine the upper and lower bound of a range to set their maximal welfare when information on the private agents' expectations formation of inflation is imperfect.