Monetary Policy and Inflation Targeting

In the 1990s, several countries shifted to a new monetary policy regime: an announced quantitative inflation target. The reason for this shift was the unsatisfactory performance under previous regimes. New Zealand, Canada, Australia, and Spain all introduced inflation targets under persistently high inflation; the United Kingdom, Sweden, and Finland did so after having abandoned fixed exchange rates, which had failed to achieve low and stable inflation and had been subject to dramatic speculative attacks. Inflation targeting has received much recent attention, both among policymakers and academics. In the United States and in Europe it is debated as a possible monetary policy strategy for the Federal Reserve System and the future European Central Bank, respectively. Academic research on inflation targeting, both theoretical and empirical, has grown quickly. My own research in the last few years has largely dealt with understanding inflation targeting in relation to other monetary policy regimes and investigating how practical monetary policy can best be conducted under inflation targeting. Practical inflation targeting has several common characteristics: 1) an announced quantitative inflation target, varying across countries between 1.5 and 2.5 percent per year, in most countries with a tolerance band of plus/minus 1 percentage point around the target; 2) no explicit rule on how the central bank shall set its instrument; 3) a floating exchange rate (except for Finland and Spain, which are members of the Exchange Rate Mechanism, although the wide exchange rate bands there so far have not created any conflict between the inflation target and the exchange rate target); and 4) a high degree of transparency and accountability. Commentators