Inflation Targets and Inflation Targeting

There is widespread agreement that price stability (in practice, low and stable inflation) should be an objective of monetary policy. This agreement is reflected both in the mandates set for monetary policy by governments and in the practice of central banks. Several other important questions about the objectives for monetary policy are less settled: Should there be other objectives? If there are multiple objectives, should one of the objectives take priority? And how explicit should the objectives be? Central banks typically operate under one of two types of mandate. A hierarchical mandate makes price stability the primary objective for monetary policy and subordinates other potential objectives. A dual mandate recognizes two objectives—price stability and full employment—and puts them on an equal footing. Either regime could make the price stability objective more precise by setting an explicit numerical target for inflation. Thus we can describe a typical central bank’s mandate and objectives in terms of two sets of alternatives: between a hierarchical or a dual mandate, on the one hand, and an implicit or explicit inflation objective, on the other hand. During the 1990s, a number of central banks adopted a framework that is called inflation targeting, combining a hierarchical mandate and an explicit inflation objective. The United States, in contrast, combines a dual mandate and an implicit inflation objective. Most of the discussion in the United States on the subject of mandates and objectives has been about whether to identify inflation as the single or primary objective and whether to move to a formal inflation-targeting regime.1 The title of my lecture— “Inflation Targets and Inflation Targeting”—is intended to differentiate between two options for changing the policy mandate for the Federal Reserve. One option, which I favor, is setting an explicit numerical target for inflation within the context of our current dual mandate. The other option, which I do not favor, is moving to an inflation-targeting regime—that is, also substituting a hierarchical mandate for our current dual mandate. The purpose of this lecture is therefore to explain the benefits of an explicit inflation target in the context of the Federal Reserve’s dual mandate and to set out the operational steps for implementing such a target. Before proceeding, let me note that the views that I am presenting here are my own. I am not speaking for the Board of Governors or the Federal Open Market Committee (FOMC).