A re-evaluation of the choice of an inflation target in the wake of the global financial crisis

ABSTRACT Through an appropriate choice of inflation objective – a real-exchange-rate-adjusted (REX) inflation target – the central bank can limit fluctuations in real economic activity which has become a cause of great concern in recent years in many small open economies. REX inflation targeting dominates CPI targeting from the standpoint of output gap stabilization. CPI inflation targeting dominates REX inflation targeting from the standpoint of stabilizing inflation, nominal interest rates and real exchange rates. These results help inform ongoing discussions of possible alternatives for the existing flexible inflation targeting framework.