Open‐Economy Inflation‐Forecast Targeting

. We study simple inflation‐forecast targeting in an open‐economy setting. Simple inflation‐forecast targeting implies setting an interest rate which, if kept unchanged throughout the forecast‐targeting horizon, produces a conditional inflation forecast equal to the inflation target at the end of the horizon. We find that the optimal forecast‐targeting horizon is relatively short (one year). A longer horizon does not consistently contribute to improved output stability, indeed it increases exchange rate variability and traded sector variability. The targeting procedure is substantially inferior to the optimal pre‐commitment policy. Moreover, the targeting procedure does not necessarily determine the rational‐expectations equilibrium and is subject to time inconsistency.