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International Finance Discussion Papers
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Roc Armenter and Martin Bodenstein
2006-885  (November 2006)

Abstract:  We argue that there are conditions such that any inflation targeting regime is preferable to full policy discretion, even if long-run inflation rates are identical across regimes. The key observation is that strict inflation targeting outperforms the discretionary policy response to sufficiently persistent shocks. Under full policy discretion, inflation expectations over the medium term respond to the shock and thereby amplify its impact on output. As a result, little output stabilization is achieved at the cost of large and persistent inflation fluctuations.

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Monetary policy, inflation targeting, rules versus discretion

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