Inflation targeting: should the Federal Reserve in its conduct of monetary policy follow the European Central Bank and adopt some form of inflation target range? TIE asked thirteen distinguished experts.

• Position: A Symposium Of Views

Some argue that while Fed Chairman Alan Greenspan, in office since 1987, has been an extraordinarily subtle and skillful manager, his successor may not enjoy these unique skills. Thus, the system needs eventually to agree on a series of guiding benchmarks if not a target for use in the conduct of monetary policy. Globally, such an additional tool might help in the convergence process and potentially create more stability for exchange rates.

Others counter that it is not wise to lock the system into a simplistic rule, or set of rules, particularly at a time of continued geopolitical uncertainty. Still others counter that the European Central Bank established provisions that have successfully anticipated such external shocks to the system.

Is the time approaching for the U.S. central bank to adopt an inflation target or inflation target range? Or does the U.S. monetary system require a more pragmatic and intuitive approach? To what extent should an inflation target be discretionary?

MILTON FRIEDMAN Senior Research Fellow, Hoover Institution, and recipient, 1976 Nobel Memorial Prize for Economic Science

Central banks the world over performed badly prior to the mid-1980s not because they lacked the capacity to do better, but because they pursued the wrong goals according to the wrong theory. Once they recognized that inflation is a monetary phenomenon and accepted price stability as their primary goal, there was a major improvement in performance. Since the mid-1980s, inflation has been decidedly lower and less volatile than earlier. That has been true for monies issued both by central banks that adopted explicit inflation targets and for those, like the U.S. Federal Reserve, that did not. Inflation targets are clearly not a necessary ingredient of a good central bank policy yet they are highly attractive as a means of codifying the responsibilities of central banks and enhancing their accountability.

OTMAR ISSING Member of the Executive Board, European Central Bank

It is, of course, a source of satisfaction to me that the European Central Bank--after only five years of operation--is mentioned as a possible model for other central banks to follow. At the same time I have always been convinced that there is no unique, universal recipe for successful monetary policy. The institutional environment and the major characteristics of economies differ substantially. In any case we would not give advice, especially not in public, on what other central banks should or should not do.

I will therefore simply sketch out what has worked well for us at the ECB. We announced our monetary policy strategy in October 1998. As a new institution responsible for a new currency area, the ECB decided not to simply copy an existing strategy, such as monetary targeting or inflation targeting. Instead we developed our own approach, best suited to our particular challenges.

The main elements of the ECB's strategy are the announcement of a quantitative definition of price stability and a two-pillar framework for the analysis of risks to price stability. The two pillars consist of economic analysis, which looks at the determinants of short-to-medium term price developments, and monetary analysis, which focuses on the monetary factors driving inflation at longer horizons. This two-pillar framework facilitates the systematic cross-checking of information from complementary analytical perspectives.

The ECB's definition of price stability--year-on-year increases in the Harmonized Index of Consumer Prices of below 2 percent--provides a firm anchor for expectations and a clear benchmark for accountability. In the context of our evaluation of our strategy in May 2003, we have clarified that we aim at inflation rates below but close to 2 percent in order to underline that a sufficient safety margin against deflation is taken into account.

The ECB does not identify a specific policy horizon but aims at maintaining price stability over the medium term. This reflects the long and variable lags in the transmission mechanism and the fact that the appropriate monetary policy response depends on the nature of shocks hitting the economy. Our experience to date has been positive despite major price shocks; measures of inflation expectations have been very stable and in line with the ECB's definition.

Overall, the ECB's monetary policy strategy has worked well. It provides a systematic framework and a clear focus for policy, but is also robust and flexible to deal with an uncertain and ever-changing environment.

EDWIN M. TRUMAN Senior Fellow, Institute for International Economics, former Assistant Secretary of the U.S. Treasury for International Affairs, and author of Inflation Targeting in the World Economy (IIE, 2003)

If the Federal Reserve were to adopt inflation targeting as its framework for the conduct and evaluation of U.S. monetary policy, it would modestly benefit the performance of the U.S. and world economy, as I argue in my recent study, Inflation Targeting in the World Economy. Federal Reserve monetary policy would be marginally more predictable and transparent within its current mandate to achieve full employment and price stability. As a result, the overall performance of the domestic economy should improve and economic policymakers in other economies would have an improved basis for formulating their policies.

On the other hand, it would be a grave mistake for the Federal Reserve to mimic the European Central Bank. The ECB is not an inflation targeting central bank. It has adopted a definition of price stability that is confusing and provides no guide to ECB policy...