Inflation targets and public debt accumulation

This paper explores the interaction between centralized monetary policy and decentralized policy in a monetary union. Discretionary monetary policy su¤ers from a failure to commit. Moreover, decentralized policymakers impose externalities on each other through the infuence of their debt policies on the common monetary policy. These imperfections can be alleviated by adopting state-contingent infation targets (to combat the monetary policy commitment problem) and shock-contingent debt targets (to internalize the externalities due to decentralized policy).

Keywords: discretionary monetary policy, decentralized policy, monetary union, infation targets, debt targets.

JEL Codes: E52, E58, E61, E62.