Price Stability as a Target for Monetary Policy: Dening and Maintaining Price Stability

This paper discusses how price stability can be de…ned and how price stability can be maintained in practice. Some lessons for the Eurosystem are also considered. With regard to de…ning price stability, the choice between price-level stability and low (including zero) in‡ation and the decisions about the price index, the quantitative target and the role of output stabilization are examined. With regard to maintaining price stability, three main alternatives are considered, namely a commitment to a simple instrument rule (like a Taylor rule), forecast targeting (like in‡ation-forecast targeting) and intermediate targeting (like money-growth targeting). A simple instrument rule does not provide a substitute for a systematic framework for monetary policy decisions. Such a framework is instead provided by forecast targeting. Forecast targeting can incorporate judgemental adjustments, extra-model information, and di¤erent indicators (including indicators of “risks to price stability”). By extending mean forecast targeting to distribution forecast targeting, nonlinearity, nonadditive uncertainty and model uncertainty can be incorporated. Eurosystem arguments in favor of its money-growth indicator and against in‡ation-forecast targeting are scrutinized and found unconvincing. JEL Classi…cation: E42, E52, E58 Keywords: In‡ation targeting, intermediate targeting, monetary targeting, Eurosystem. ¤This paper was presented at the Bundesbank conference on “The Monetary Transmission Process: Recent Developments and Lessons for Europe,” March 26–27, 1999. I thank the discussants Mervyn King and José Viñals, and Claes Berg, Donald Brash, John Faust, Torsten Persson, Anders Vredin and participants in seminars at IIES and Sveriges Riksbank for comments. Special thanks are due to Jon Faust and Dale Henderson. Over the years, I have bene…ted a great deal from many discussions with them on monetary policy and from their very constructive (sometimes relentless) criticism of previous work of mine. Dale has also directed me to an early, very relevant, literature. I also thank Christina Lönnblad for editorial and secretarial assistance and Marcus Salomonsson for research assistance. Needless to say, the views expressed and any errors are my own responsibility.