A behavioural analysis of time inconsistency in macroeconomic policy-making

As central bankers around the world struggle to contain inflation, the efficacy of inflation targeting is being challenged. Was inflation targeting only ever seeming to work because it had no work to do? In addressing these questions, this paper distinguishes then reconciles time inconsistency concepts from rational expectations and behavioural economics to show that the inflation bias identified in rational expectations models will be magnified in the presence of behavioural present bias. The range of enforceable inflation targets decreases as present bias increases, suggesting that inflation targeting tools should be refined to address the inflationary impacts of policy-makers’ present bias.