Rethinking Inflation Targeting

Farewell to Inflation Targeting?

The Failure of Inflation Targeting

But inflation targeting was never an obvious concept, and the financial crisis has discredited it. In 2003, Ben Bernanke, then a Governor of the US Federal Reserve, stated in a speech that many Americans considered inflation targeting foreign, impenetrable, and possibly slightly subversive.

In that regard, Governments may wish to consider inflation targeting as a possible option, as well as acting to eliminate fuel subsidies.

But then oil and gas prices (adjusted for inflation) entered a multi decade period of decline. Policies targeting energy efficiency and security largely lapsed.

The struggle to meet rising food and energy prices is hard enough. The weaker economy and higher unemployment that inflation targeting brings won t have much impact on inflation it will only make the task of surviving in these conditions more difficult.

Some policymakers have concluded from Phelps analysis that the unemployment rate cannot be lowered permanently without ever increasing levels of inflation. Thus, monetary authorities should simply focus on price stability by targeting the rate of unemployment at which inflation does not increase, referred to as the non accelerating inflation rate of unemployment (NAIRU).

In a more global context, none of this is to dismiss the longer term dangers of inflation. In most countries, at most times, inflation should be kept very low and central banks should anchor inflation expectations with a stable long term target, although the alternative of targeting nominal GDP deserves to be discussed.

BEIJING Fixated on inflation targeting in a world without inflation, central banks have lost their way. With benchmark interest rates stuck at the dreaded zero bound, monetary policy has been transformed from an agent of price stability into an engine of financial instability.

Ironically, the inflation targeting advocated by Greenspan s nominated successor, Ben Bernanke, lies closer to ECB monetary policy than to the discretionary activism that the Fed has practiced during Greenspan s long tenure.

Inflation targeting means that a central bank puts the pursuit of price stability above all other objectives. This is what the ECB does and what the Fed s Alan Greenspan does not do.

This focus supported the ascendancy of inflation targeting as the favored monetary policy framework and, in turn, led to operational independence for central banks. The policy was a success the discipline imposed by strict and rigorous concentration on a sole objective enabled policymakers to control and then conquer inflation.

Finally, some promising ideas have virtually never been tried at all denominating bonds in oil prices instead of dollars, to protect against the risk of a price decline choosing commodity price targeting as an alternative to inflation targeting or exchange rate targeting for anchoring monetary policy and distributing oil revenues on a nationwide per capita basis, to ensure that they do not wind up in elites Swiss bank accounts.

All the major Western central banks including even the traditionally hawkish ECB appear to be sticking their heads in the sand. But there is something they can do to ensure the benefits of inflation targeting rules (credibility and well anchored inflation expectations) while also supporting recovery raise the stated target.

Moreover, the US Federal Reserve is targeting a 4 annual inflation rate. This alone means that under normal circumstances the purchasing power of China s foreign exchange reserves will automatically depreciate by 4 each year.

These ideas, combined with effective policy practice like that of the US Federal Reserve under Paul Volcker s chairmanship, led many countries worldwide toward more explicit inflation targeting, in which central banks stabilize inflation expectations by making a credible commitment to a predetermined rate of price growth. By the 1990 s, inflation was old news in the advanced economies, with much of the developing world soon to follow.

Japan faces a different conundrum. Haruhiko Kuroda, the Bank of Japan s new governor, has sent a clear signal to markets that the BOJ is targeting 2 annual inflation, after years of near zero price growth.

A more recent indication that inflation targeting has not caused the disinflation seen since the 1990s is the unsuccessful effort by a growing number of central banks to reflate their economies. If central banks are unable to increase inflation, it stands to reason that they may not have been instrumental in reducing it.

Targeting the Targeters

Here, too, the record since 1980 has been patchy, despite the huge deflationary pressure exerted by low wage competition from Asia. Inflation in 1950 1973 and 1980 2007 was about the same just over 3 while inflation targeting has failed to prevent a succession of asset bubbles that have brought recessions in their wake.

This prideful interpretation amounted to the siren song of an extremely accommodative monetary policy. Unable to disentangle the global and domestic pressures suppressing inflation, a price targeting Fed has erred consistently on the side of easy money.

Legal advice on targeting

But, as a consequence of this narrow approach, policymakers disregarded the formation of asset and commodity price bubbles, and overlooked the resulting banking sector instability. This, by itself, calls for a review of the overall efficacy of inflation targeting.

Phelps was also 10 to 20 years ahead of the profession when he developed the theories of wage efficiency and inflation targeting, which are now considered to be the state of the art concerning the labour market and monetary management.

Interestingly, Reinhart and Rogoff broadly agree with this recommendation (at least for the US), and they even support heterodox policies such as writing down mortgages and targeting a higher inflation rate. But their paper is really about a different subject.

But, rather than recognize the likely drivers of these developments namely, a seemingly chronic shortfall of global aggregate demand amid a supply glut and a deflationary profusion of technological innovations and new supply chains the Fed continues to minimize the deflationary impact of global forces. It would rather attribute low inflation to successful inflation targeting, and the Great Moderation that it presumably spawned.

The current high stakes conundrum faced by policymakers suggests that they should apply inflation targeting principles more flexibly in the context of a major economic shock. This would involve raising the target to a level in line with the actual inflation rate observed in the post crisis period a level that the public would perceive as realistic, honest, and credible.

(b) In the formal targeting procedures?

(b) in the formal targeting procedures

(b) in the formal targeting procedures?

Most central bankers really are targeting growth, inflation, and financial stability, if not necessarily in that order. The political bubble is an inevitable product of central bank independence, and preventing monetary policy from becoming a target for elected officials requires constant effort.

So we're targeting 50 dollars in 2010.

The inflation targeting models used by the Fed (and other central banks and official institutions like the International Monetary Fund) all assume the existence of some pre determined limit to non inflationary unemployment. The Fed s latest model estimates this NAIRU to be 4.9 5.2 .

The main change was a large reduction in interest rates, in line with an inflation targeting framework, which has led to a more competitive exchange rate policy. This was combined with a counter cyclical fiscal policy has that kept deficits and public debt under control.

Indeed, some countries are ditching their inflation targeting regime and moving into uncharted territory, where there may be no anchor for price expectations. The US has moved from QE1 to QE2 and now to QE3, which is potentially unlimited and linked to an unemployment target.

For example, some inflation targeting central banks have reacted to increases in prices of imported commodities by tightening monetary policy and thereby increasing the value of the currency. But adverse movements in the terms of trade must be accommodated they cannot be fought with monetary policy.

This Volcker moment was, as students of economic history know, the catalyst not only for winning the war against inflation, but also for a multi decade shift in conventional wisdom about central banking. Most important, inflation targeting and independence from the fiscal authorities became core features of mainstream policy a requirement for any country seeking the macroeconomic stability deemed crucial for sustained economic growth and high rates of job creation.

Forget Inflation

A similar initiative is now targeting persistent organic pollutants.

Four Parties proposed projects targeting improved efficiency of lighting.

The Monitoring Team notes the conclusions of the September 11 Commission that targeting travel is at least as powerful a weapon against terrorists as targeting their money .

Overall, longline vessels targeting swordfish had the lowest average annual profit, 11,000, while longline vessels targeting tuna and mixed species earned 20,000 and 47,000 per year, respectively.

Out goes the fusty old inflation targeting regime, with its fixation on the consumer price index and disregard for financial sector imbalances. In comes a brave new world of state contingent threshold based forward guidance, complete with three conditional knockouts that would cause the guidance to be changed.

The search for a monetary rule during the latter period had two phases in the earliest attempt to construct a basis for stable monetary policy, the emphasis was on monetary targeting. In the second, more successful, phase, an increasing number of countries adopted either explicit or implicit inflation targets.