Economic Quarterly

In a simple new Keynesian model of monetary policy under discretion, constraining the central bank to put inflation within a prespecified inflation target zone can greatly mitigate biases stemming from lack of time consistency in monetary policy. Specifically, it can eliminate the inflation bias and, at least for certain parameter zones, significantly reduce the stabilization bias. Also, one can use the model to investigate what are the optimal inflation target zones for different economies. These optimal zones seem to depend on the structural parameters in a nonlinear and often nonmonotonic way.