Growth and inflation targeting by the government and the central bank: Alignment or conflict?

Abstract

We model a stochastic dynamic optimization problem for the government and bank, targeting growth and inflation. These significant objectives are not necessarily aligned. We use a dynamic strategic interaction model under uncertainty, where the two parties involved take decisions alternately. We posit a suitable cost of deviation and joint value function to be optimized. We also demonstrate target achievability and provide real empirical and simulated numerical results that support our conclusions. We highlight that duality leads to a trade-off and, due to staggered decision making, fluctuations in target achievement are inevitable and not proof of inefficiency.