Average Inflation Targeting: Time Inconsistency and Intentional Ambiguity
||Original Paper: WP 21-19|
We study the implications of the Fed's new policy framework of average inflation targeting (AIT) and its ambiguous communication. The central bank has the incentive to deviate from its announced AIT and implement inflation targeting ex post to maximize social welfare. We show two motives for ambiguous communication about the horizon over which the central bank averages inflation as a result of time inconsistency. First, it is optimal for the central bank to announce different horizons depending on the state of the economy. Second, ambiguous communication helps the central bank gain credibility.
Keywords: Bayesian VARs, stochastic volatility, pandemics.
JEL classification codes: E52, E31, E58.
Suggested citation: Jia, Chengcheng, and Jing Cynthia Wu. 2022. "Average Inflation Targeting: Time Inconsistency and Intentional Ambiguity." Working Paper No. 21-19R. Federal Reserve Bank of Cleveland. https://doi.org/10.26509/frbc-wp-202119r.