In Noise We Trust? Optimal Monetary Policy with Random Targets

QAU Working Paper No. QAU07-1
by Ethan Cohen-Cole and Bogdan Cosmaciuc

Monetary policy in which the central bank commits to a randomized inflation target allows for potentially faster expectations convergence than with a fixed target. Randomization acts as a substitute for full credibility, enabling the central bank to transfer its intent to the economy more quickly. With a fixed target, individual occurrences of high inflation are regarded as confirming the low credibility of the institution. Under a random target, such events can be regarded as generated by the randomization process and thus harm credibility less on the margin. We thus emphasize the role of this mechanism in particular in transition environments.

JEL codes: E52, E61, E42

Keywords: monetary policy, credibility, emerging economies

PDF version of paper

Stay Connected