Sacrifice Ratios and Inflation Targeting: The Role of Credibility

Abstract

Two recent papers (Gonçalves and Carvalho, 2009; and Brito, 2010) hold contradictory views regarding the role of inflation targeting during periods of disinflation. The first paper claims that inflation targeting reduces sacrifice ratios — i.e., the ratio of output losses to the change in trend inflation — during disinflations; the second paper refutes this result. We show here that inflation targeting only matters if disinflations are slow. The credibility gains of a fast disinflation make inflation targeting irrelevant for reducing the output-inflation trade-off.

Keywords: Inflation Targeting, Disinflation, Monetary Policy, Sacrifice Ratios, Credibility

JEL Classification: E31, E32, E52, E58