Average Inflation Targeting: Time Inconsistency and Ambiguous Communication

Abstract

We study the implications of average inflation targeting (AIT). AIT improves the inflation-output trade-off when the private sector believes the central bank’s announcement. Ex post, the central bank has the incentive to implement inflation targeting instead to maximize social welfare. Next, we examine whether and how the central bank can convince the private sector, and find ambiguous communication helps the central bank gain credibility and improve welfare. These results apply to several key aspects of AIT announcement and do not rely on specific modeling assumptions.

Keywords: inflation expectations, average inflation targeting, time inconsistency, ambiguous communication

JEL Classification: E52, E31