This paper investigates theoretically using an economic model
whether inflation targeting policy is an optimum policy or not in
developing countries, where central banks have engaged in quasi
fiscal activities. Technically, the paper compares between two strategies;
inflation targeting policy and Morris and Shin (2002a) strategy,
in which the expected inflation rate is built based on external
and internal signals.
The result proves that inflation targeting policy is not an optimum
under a dependent central bank. Agents in developing countries do
not react to inflation targeting policy because of the high uncertainty
level. They prefer to rely on external signals. Moreover, we
prove that an effective inflation targeting policy requires more economic
certainty and stability.