Policy Targeting with Model-Consistent Expectations

Pub. Date
14 May, 2004
Pub. Type

Studies of inflation targeting make the distinction between strict and flexible inflation targeting. The problem of strict inflation targeting has so far been analysed by treating it as a special case of a standard optimal control problem and the algorithms used have not provided an exact solution. This paper presents a formal solution to the problem of strict inflation targeting in a economy with a forward-looking variable. It explains how the results can be applied with more than one forward-looking variable. It also draws on relevant control theory results. The results are illustrated on a small macro-economic model. It is shown that the use of a solution method which exploits the existence of a forward-looking variable delivers a solution which would not be easy to find by standard control methods.