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The Inflation-Targeting Debate$
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Ben S. Bernanke and Michael Woodford

Print publication date: 2005

Print ISBN-13: 9780226044712

Published to Chicago Scholarship Online: February 2013

DOI: 10.7208/chicago/9780226044736.001.0001

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PRINTED FROM CHICAGO SCHOLARSHIP ONLINE (www.chicago.universitypressscholarship.com). (c) Copyright University of Chicago Press, 2021. All Rights Reserved. An individual user may print out a PDF of a single chapter of a monograph in CHSO for personal use.date: 19 September 2021

Limits to Inflation Targeting

Limits to Inflation Targeting

(p.283) 7 Limits to Inflation Targeting
The Inflation-Targeting Debate

Christopher A. Sims

University of Chicago Press

Inflation targeting requires central banks not only to explain how their current actions relate to their view of the future course of the economy, but also to be explicit about how precisely they can control inflation. However, there are bounds, set by fiscal policy broadly conceived, on the central bank's control over inflation. It may lose control of a deflation. As a theoretical possibility, the lack of a credible fiscal policy may open the door to equilibria in which accelerating inflation leads to demonetization of the economy, even when policies are also consistent with stable equilibria. This chapter first models both bonds and money in order to discuss policy in terms of an interest rate rule. It then introduces a foreign currency-denominated asset, in order to consider a central bank with reserves only and no access to a backup taxing power. The model retains the “inflationary demonetization” equilibria, which can be avoided only with tax backing or reserves. Finally, the chapter discusses the pros and cons of inflation targeting and ways of improving it.

Keywords:   inflation targeting, fiscal policy, deflation, inflationary demonetization, reserves, tax backing, interest rate rule, bonds, money, central banks

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