Question

Which of the four rules you considered above is subject to the time inconsistency problem?

1) A legally fixed money growth rate of 2
2) A rule that targets a specific inflation rate
3) A rule that targets a specific unemployment rate
4) A rule that targets a specific interest rate

Answer 1

A rule that targets a specific inflation rate is subject to the time inconsistency problem.

Step-by-step explanation:

Out of the four rules mentioned, a rule that targets a specific inflation rate is subject to the time inconsistency problem. This is because economic conditions can change over time, and achieving a specific inflation rate may conflict with other policy goals, such as reducing unemployment or promoting economic growth. When faced with a recessionary gap, a central bank may need to implement expansionary policies that could lead to higher inflation, even if they had previously targeted a lower inflation rate. Therefore, targeting a specific inflation rate may not always be feasible in practice.