This paper presents a model for Inflation Targeting under imperfect policy credibility. It modifies the conventional … model in three ways: an endogenous policy credibility process, by which monetary policy can gain or lose credibility over … time; non-linearities in the inflation equation and in the credibility generating process; and an explicit loss function …

Under the assumption of no arbitrage exchange rate target zone credibility is tested by whether domestic interest rates … absent a devaluation. Under the assumption of uncovered interest rate parity credibility is tested by whether expected future …