Panel Discussion: Inflation Targeting

economy is operating in the region of price stability, public expectations and beliefs about the central bank’s plans and objectives, always important, become even more so. First, because the public can no longer safely assume that the central bank prefers lower to higher inflation, expectations about future policy actions and future inflation may become highly sensitive to what the public perceives to be the Fed’s “just right” level of inflation. Uncertainty about this “just right” level of inflation thus may translate, in turn, into broader economic and financial uncertainty. Second, at very low inflation rates, the zero lower bound on the policy interest rate is more likely to become relevant, which increases the potential importance of effective expectations management by monetary policymakers. For example, when interest rates are very low, the best way to ease policy may be to explain to the public that the current low interest rate will be maintained for a longer period, rather than simply lowering the current rate. It seems to me that the enhanced importance of public beliefs and expectations about monetary policy in the region of price stability argues for greater attention by the central bank to its methods of communication when inflation is low. On the premise that effective communication is even more crucial near price stability, I will focus today on how an incremental move toward inflation targeting, in the form of the announcement of a longrun inflation objective, might help the Fed communicate better and perhaps improve policy decisions as well, without the costs feared by those concerned about a potential loss of flexibility. As usual, my views are not to be attributed to my colleagues on the Board of Governors of the Federal Reserve System or the Federal Open Market Committee. As a preliminary, I need to introduce the idea of the optimal long-run inflation rate, or OLIR for short. (Suggestions for a catchier name are welcome.) Panel Discussion