Report

The advantage of flexible targeting rules

Abstract: This paper investigates the consequences of debt stabilization for inflation targeting. If the monetary authority perfectly stabilizes inflation while the fiscal authority holds constant the real value of debt at maturity, the equilibrium dynamics might be indeterminate. However, determinacy can be restored by committing to targeting rules for either monetary or fiscal policy that include a concern for stabilization of the output gap. In solving the indeterminacy problem, flexible inflation targeting appears to be more robust than flexible debt targeting to alternative parameter configurations and steady-state fiscal stances. Conversely, flexible fiscal targeting rules lead to more desirable welfare outcomes. The paper further shows that if considerations beyond stabilization call for a combination of strict inflation and debt targeting rules, the indeterminacy result can be overturned if the fiscal authority commits to holding constant debt net of interest rate spending.

Keywords: interaction of fiscal and monetary policy; equilibrium determinacy;

JEL Classification: E61; E63;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2008-07-01

Number: 339

Note: For a published version of this report, see Andrea Ferrero, "The Advantage of Flexible Targeting Rules," Journal of Money, Credit, and Banking 44, no. 5 (August 2012): 825-62.