Monetary Policy and Inflation Targeting

On 21–22 July 1997, the Bank convened a conference entitled, 'Monetary Policy and Inflation Targeting'. The following excer pt is the introductory chapter of the conference volume. Medium-term price stability is widely accepted as the appropriate ultimate goal for monetary policy. This reflects two ideas. The first is that high rates of inflation distort decision-making, ultimately leading to slower economic growth. The second is that monetary policy is the most effective instrument in influencing medium-term inflation outcomes. By pursuing a strategy that ensures that inflation does not distort decisions concerning investment, production and savings, monetary policy is best able to contribute to sustainable improvements in living standards. A variety of monetary policy frameworks is consistent with achieving this objective, although there has been a shift over recent years to forms of inflation targeting. Even in countries without an explicit inflation target, there is often a strong commitment to an implicit medium-term inflation objective. Further, countries that have chosen to fix their exchange rate have typically done so against a country with some form of implicit or explicit inflation objective. While the move to inflation targets has made the ultimate goal of monetary policy more transparent, it has not meant that central banks have eschewed all attempts to mitigate cyclical fluctuations in output and employment. Indeed, most central banks aim to reduce the amplitude of the business cycle, not only because this often helps the task of inflation control, but also because steady, sustained growth is likely to lead to better medium-term outcomes than is a process of 'stop-go' growth. The focus of monetary policy on price stability has contributed to a remarkable convergence of inflation rates; most OECD countries now have inflation rates of around 3 per cent or less, with the differences between countries currently smaller than at any time since the early 1960s. This convergence of outcomes has also been helped by the generally benign international economic environment over recent years and the processes of international integration and product-and labour-market reform. However, while these developments have contributed to the recent low inflation outcomes, they do not by themselves ensure a continuation of low inflation. This remains the responsibility of monetary policy. The papers in this volume were commissioned by the Bank to examine how this responsibility may best be met. The papers in Part I examine the arguments for and against various operational frameworks for monetary policy, including …