The Advantage of Flexible Targeting Rules

Abstract

This paper investigates the consequences of debt stabilization for inflation targeting. If the fiscal authority holds constant the real value of debt at maturity under strict inflation targeting, the equilibrium dynamics are indeterminate for a wide range of parameters and steady-state fiscal stances. "Flexible" targeting rules that include a concern for stabilization of the output gap can restore determinacy of the equilibrium. Flexible inflation targeting appears to be more robust than flexible debt targeting to alternative parameterizations. The fiscal authority can prevent indeterminacy under strict targeting rules by committing to hold constant debt net of interest rate spending. © 2012 The Ohio State University.