On optimal contracts for central bankers and inflation and exchange-rate-targeting regimes

This paper analyzes the issues of discretion and commitment in monetary policy under an exchange rate-targeting regime. Neither a linear state-contingent inflation contract for the central bank nor an explicit state-contingent inflation target combined with a weight-conservative central bank can now achieve the commitment equilibrium. It is shown that a state-contingent contract conditioned on the exchange rate and past output can implement the commitment equilibrium. Contracts conditioned on the exchange rate and inflation and on inflation and past output can also mimic the optimal rule under commitment.