Average Inflation Targeting: Time Inconsistency and Intentional Ambiguity
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.
We are grateful to Todd Clark, Oli Coibion, Drew Creal, Yuriy Gorodnichenko, Kinda Hachem, Andy Levin, Kurt Lunsford, Thomas Mertens, Ayşegül Şahin, Eric Sims, Eric Swanson, and Michael Woodford, as well as seminar and conference participants at the NBER Monetary Economics Program Meeting, AEA Annual Meeting, Federal Reserve Bank of Cleveland, Bank of Israel. The views stated herein are those of the authors and are not necessarily those of the Federal Reserve Bank of Cleveland or the Board of Governors of the Federal Reserve System. Wu acknowledges support from the National Science Foundation under Grant No. SES- 1949107. Correspondence: Chengcheng.Jia@clev.frb.org, firstname.lastname@example.org. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.