Arguments pro
By focusing attention on a goal the Fed can achieve, by making
monetary policy more transparent and increasing public understanding
of the Fed's strategy and tactics, by creating institutions that
foster good policy, and by improving accountability, the adoption of
inflation targeting would represent a desirable change in the U.S.
monetary policy.
1. The announcement of explicit inflation targets for the Fed would
provide a clear monetary policy framework that would focus attention
on what the Fed actually can achieve. Bad monetary policy often has
resulted from demands that central banks attempt to achieve the
unachievable. Most notably, few macroeconomists believe that monetary
policy can be used to lower the average rate of unemployment
permanently, but central banks often are pressured to achieve just
that through expansionary policy; such policy instead only results in
higher average inflation without leading to a systematically lower
average rate of unemployment. In contrast, implementing explicit
inflation targets would help to insulate the Fed from such political
pressure.
2. Transparent inflation targets in the U.S. would help anchor
inflation expectations in the economy. When making real and financial
investment decisions and planning for the future, businesses and
individuals must form expectations about future inflation. Inflation
targets would provide a clear path for the medium-term inflation
outlook, reducing the size of inflation "surprises" and their
associated costs. Inflation targets also likely would boost the Fed's
credibility about maintaining low inflation in the long run, in part,
because they mitigate the political pressure for expansionary policy.
Since long-term interest rates fluctuate with movements in inflation
expectations, targeting a low rate of inflation would lead to more
stable and lower long-term rates of interest. Together, the reduced
uncertainty about future medium-term and long-term inflation would
have beneficial effects for financial markets, for price and wage
setting, and for real investment.
3. The establishment of inflation targets in the U.S. would help
institutionalize good monetary policy. Recent U.S. monetary policy has
been generally considered excellent, but earlier in the postwar
period, monetary policy clearly failed by allowing inflation to
ratchet up significantly several times. To some extent, the quality of
policy over time has reflected the skills and attitudes of the people
involved in the policy process. Monetary policy is an area in which it
is especially important to implement institutional structures that
will help to avoid bad policies. Inflation targets can provide this
institutional structure and help ensure that monetary policy is not
dependent on always having the good luck to appoint the best people.
4. In the current system, there is some ambiguity about how and why
the Fed operates. For example, although monetary aggregates play a
very modest role in the policy process,they are the only variables
that the Fed is required to set target ranges for and report about to
Congress. As noted above, inflation targets would focus discussion on
what the Fed actually could achieve. Furthermore, an inflation target
provides a clear yardstick by which to measure monetary policy. Given
forecasts of future inflation, it is easy to compare them to the
announced inflation target and hence judge the appropriate tightness
or looseness of current monetary policy. Also, on a retrospective
basis, an explicit target allows Fed performance to be easily
monitored. Thus, Congress and the public will be better able to assess
the Fed's performance and hold it accountable for maintaining low
inflation.
Arguments con
Inflation targeting, even without imposing a rigid rule, would unduly
reduce the flexibility of the Fed to respond to new economic
developments in an uncertain world. Furthermore, publicly committing
solely to an inflation target would not enhance overall accountability
or transparency given the multiple objectives of monetary policy.
1. The purpose of inflation targeting is to focus the attention of
monetary policy on inflation. However, concentrating on numerical
inflation objectives (even with caveats or escape clauses) also
reduces the flexibility of monetary policy, especially with respect to
other policy goals. That is, inflation targets place some constraints
on the discretionary actions of central banks. Such constraints can be
quite appropriate in countries where monetary policy has performed
poorly, exhibiting sustained unproductive inflationary tendencies;
however, this is not the case in the United States. U.S. monetary
policy has operated quite well for almost two decades, so limiting the
flexibility and discretion of the Fed to respond to new economic
developments would be ill-advised. Why change a system that is
working? Certainly, adept policymakers are one reason for the good
performance of recent monetary policy, but there is also a strong
institutional structure--stronger than existed at the start of the
1970s--that is already in place at the Fed that fosters good monetary
policy.
2. Monetary policy requires the careful balancing of competing
goals--financial stability, low inflation, and full employment--in an
uncertain world. There is uncertainty about the contemporaneous state
of the economy, the impact policy actions will have on future economic
activity and inflation, and the evolving priority to be given to
different policy objectives. However, because monetary policy actions
affect inflation with a lag, inflation targeting means, in practice,
that the Fed would need to rely heavily on forecasts of future
inflation. Given the uncertainties the Fed faces, an inflexible and
undue reliance on inflation forecasts can create policy problems. For
example, most forecasts in the mid-1990s of inflation in the late
1990s over-estimated the inflation we are currently experiencing. If
the Fed had been inflation targeting in the mid-1990s, it might well
have raised the funds rate based on its inflation forecasts. Yet with
today's low inflation and robust economy, it is difficult to argue
that the Fed was too expansionary and that the more contractionary
policy implied by inflation targeting would have produced a better
outcome. As in this instance, it seems unlikely that a mechanical
dependence on inflation forecasts to achieve inflation targets will
improve policy.
3. Proponents of inflation targeting argue that it promotes
accountability. However, as is generally agreed, low inflation is only
one of the objectives of monetary policy. While monetary policy may
not affect average real growth or unemployment over time, it does have
an important role to play in helping to stabilize the economy. Even if
average inflation is the one thing the Fed can control in the long
run, it does not follow that the Fed should be held accountable only
for its inflation record. Inflation targeting actually could reduce
the Fed's overall accountability by allowing it to avoid
responsibility for damping short-run fluctuations in real economic
activity and unemployment. Making the Fed publicly accountable for
only one policy goal may make it harder for Congress and others to
monitor the Fed's contribution to good overall macroeconomic policy.
4. Similarly, with regard to the transparency and public understanding
of policy, inflation targeting highlights the inflation objective of
central banks but tends to obscure the other goals of policy. Just as
uncertainty about future inflation impedes good economic decision
making, so does uncertainty about the future level of output and
employment. Inflation targeting sweeps the latter concerns under the
rug (often by adjusting the amount of time that deviations are allowed
from the inflation target). Given the multiple legitimate goals of
policy, the single public focus of inflation targeting does not
enhance overall transparency. |
