Transparency, Expectations Anchoring and the Inflation Target

This paper proves that a higher inflation target unanchors expectations, as feared by Fed Chairman Bernanke. The higher the inflation target, the smaller the E-stability region when a central bank follows a Taylor rule in a New Keynesian model allowing for trend inflation and adaptive learning. Moreover, the higher the inflation target, the more the policy should respond to inflation and the less to output to guarantee E-stability. Hence, a policy that increases the inflation target and increase the monetary policy response to output would be "reckless". Moreover, we show that transparency is an essential component of the inflation targeting framework and it helps anchoring expectations. However, the importance of being transparent diminishes with the level of the inflation target.