In‡ation Targets as Focal Points¤

In a world characterised by noisy information and con‡icting signals, no Central Bank is always able to a¤ect private sector expectations. Based on Morris and Shin’s model, monetary policy then becomes an informa-tion game, in which individuals form their expectations based on all the information that is available to them (public and private). However indi-vidual agents also know that ultimately in‡ation is a¤ected by both the objectives of the Central Bank (and hence the policies it pursues) as well as the average expectation formed by the all agents. They thus need to evaluate both actions. Central to our argument is the way that individuals interpret these actions to form their expectations. We apply Bacharach’s methodology to provide a framework for assessing everyone’s interpreta-tions. Our contribution is to merge these two models to show that a monetary policy regime that has explicit quantitative objectives may pro-vide individuals with better anchors for expectations to coordinate at. However, that is only true …rst, if no great shocks are anticipated to hit the economy and second, when all other public information is very unclear thus rendering the in‡ation target the only clear piece of information. We derive in detail the conditions under which this is true