Inflation Targeting
The framework New Zealand invented in 1989, assessed against later adopters.
Summary
Ben Bernanke, Thomas Laubach, Frederic Mishkin and Adam Posen wrote this comparative assessment of inflation targeting at a point when the framework had been adopted by a handful of countries and was being debated for the United States. It combines a theoretical treatment with case studies of New Zealand, Canada, the United Kingdom, Sweden, Israel and the earlier monetary targeting of Germany and Switzerland.
The central conceptual claim is that inflation targeting is constrained discretion rather than a rule. Under it a central bank announces a numerical objective and accepts accountability for meeting it, but retains freedom to respond to shocks over the medium term. The authors argue that this framework anchors expectations, which lowers the output cost of disinflation, while avoiding the rigidity that made monetary aggregate targeting fail. They examine what happened to inflation, output and expectations in each adopting country, and conclude that the framework improved outcomes without the credibility bonus that some advocates had predicted, since disinflation still cost output.
The book was written before inflation targeting became near-universal and before the 2008 crisis raised the question of whether a framework focused on consumer prices can accommodate financial stability. Bernanke's own later experience as Federal Reserve chairman, including the adoption of an explicit two per cent target in 2012 and the later shift to flexible average inflation targeting, complicates several of the positions taken here. The case studies remain the most useful part, since they record what each central bank actually did rather than what the framework prescribed.
Key takeaways 7
- Inflation targeting is constrained discretion, not a mechanical rule, and its advocates should stop describing it as the latter.
- Announcing a numerical target anchors expectations and lowers the output cost of subsequent disinflation, though it does not eliminate that cost.
- Countries that adopted inflation targeting did not receive an immediate credibility bonus, and had to earn credibility through performance.
- Monetary aggregate targeting failed because the relationship between money and prices proved unstable, while inflation targeting fixes on the variable of interest directly.
- Transparency about forecasts and about policy reasoning is part of the framework rather than an optional addition to it.
- Central bank independence must be paired with accountability mechanisms, and an explicit target supplies the standard against which to hold the bank.
- The framework should target inflation over a medium-term horizon, because attempting to hit the target every quarter destabilises output.
Who should read it
Investors and analysts who need the intellectual foundations of the monetary framework most central banks still operate, stated by people who later ran one.
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