Why Inflation Targeting may Partly Substitute for Explicit Precommitment

This paper considers an institutional arrangement, in which the government assigns a publicly announced inflation target to an instrument independent central bank, but retains the discretion to revise the target after wages have been set. We argue that since this arrangement is perfectly transparent, it resolves Canzoneri's private information problem, ensures perfect monitoring of the government, and enhances the effectiveness of reputational forces. The paper characterizes cases in which, for this reason, inflation targeting mitigates the inflationary bias of monetary policy.