In an open-economy faced with parameter uncertainty, this paper uses distribution forecasts to investigate the impact of alternative inflation targeting policies on macroeconomic volatility and their potential implications on financial stability. Theoretically, Domestic Inflation Targeting (DIT) leads to less volatility than Consumer Price Index Inflation Targeting (CPIIT) for several macroeconomic variables and, in particular, for the interest rate. Empirically, a positive relationship between interest rate volatility and financial instability emerges for the US, UK and Sweden since the early 1990s. Bridging theory and empirical evidence, we conclude that the choice of the inflation targeting regime has an important impact on macroeconomic volatility and potential implications for financial stability.

The performance of alternative institutional mandates in achieving macroeconomic and financial stability is studied in a model with financial frictions and reserve requirements as the main instrument of macroprudential regulation. The analysis shows that under a policy loss evaluation approach, coordination leads to a substantial gain in stability in response to various shocks, with the policy interest rate and the required reserve ratio exhibiting a high degree of complementarity. The latter is also more efficient than the former in promoting financial stability. In addition, it is optimal to delegate the financial stability goal also to the monetary authority when the financial regulator only operates a credit-based reserve requirements rule. These results hold under a utility-based welfare evaluation approach as well, as long as the central bank’s institutional mandate focuses mainly on macroeconomic stability. Thus, when the mandate bestowed to policymakers by society accounts for financial stability, evaluating the performance of policy regimes based solely on a welfare criterion could be inappropriate.