Inflation Targeting

Inflation targeting is a monetary-policy strategy that was introduced in New Zealand in 1990, has been very successful in terms of stabilizing both inflation and the real economy, and as of 2007 had been adopted by more than 20 industrialized and non-industrialized countries. It is characterized by an announced numerical inflation target, an implementation of monetary policy that gives a major role to an inflation forecast and has been called 'inflation-forecast targeting', and a high degree of transparency and accountability. Inflation targeting is a monetary-policy strategy that was introduced in New Zealand in 1990, has been very successful, and as of 2007 had been adopted by more than 20 industrialized and non-industrialized countries. It is characterized by (a) an announced numerical inflation target, (b) an implementation of monetary policy that gives a major role to an inflation forecast and has been called 'inflation-forecast targeting', (c) and a high degree of transparency and accountability. The numerical inflation target is typically around two per cent at an annual rate for the Consumer Price Index (CPI) or a core CPI, in the form of a range, such as one to three per cent in New Zealand; or a point target with a range, such as a two per cent point target with a range/tolerance interval of plus/minus one percentage points in Canada and Sweden; or a point target without any explicit range, such as two per cent in the UK and 2.5 per cent in Norway. The difference between these forms does not seem to matter in practice: a central bank with a target range seems to aim for the middle of the range, and the edges of the range are normally interpreted as 'soft edges' in the sense that they do not trigger discrete policy changes, and being just outside the range is not considered much different from being just inside. In practice, inflation targeting is never 'strict' inflation targeting but always 'flexible' inflation targeting, in the sense that all inflation-targeting central banks ('central bank' is used as the generic name for monetary authority) not only aim at stabilizing inflation around the inflation target but also put some weight on stabilizing the real economy, for instance, implicitly or explicitly stabilizing a measure of resource utilization such as the output gap between actual output and 'potential' output. Thus, the 'target variables' of the central bank include not only inflation but other variables as …