Inflation Targeting Turns 20

• Author: Scott Roger
• Position: Senior Economist in the IMF’s Monetary and Capital Markets Department

TWO decades ago, New Zealand adopted a new approach to monetary policy, based on achieving a specific target for inflation. What made this approach new was the explicit public commitment to controlling inflation as the primary policy objective and the emphasis on policy transparency and accountability.

Today 26 countries use inflation targeting, about half of them emerging market or low-income economies (see table). Moreover, a number of central banks in more advanced economies-including the European Central Bank, the U.S. Federal Reserve, the Bank of Japan, and the Swiss National Bank-have adopted many of the main elements of inflation targeting, and several others are in the process of moving toward it.

This article examines how inflation targeters have performed over the past 20 years-including during the commodity price shocks of 2006-08 and the global financial crisis that began in 2007. The article also highlights some especially important issues inflation targeters are likely to face in the next few years.

The inflation-targeting framework

From the outset, inflation-targeting frameworks have included four main elements (Mishkin, 2004; and Heenan, Peter, and Roger, 2006):

* an explicit central bank mandate to pursue price stability as the primary objective of monetary policy and a high degree of operational autonomy;

* explicit quantitative targets for inflation;

* central bank accountability for performance in achieving the inflation objective, mainly through high-transparency requirements for policy strategy and implementation; and

* a policy approach based on a forward-looking assessment of inflation pressures, taking into account a wide array of information.

These elements reflect both theory and experience that suggest central banks cannot consistently pursue and achieve multiple goals, such as low inflation and low unemployment, with only one basic instrument-the policy interest rate (for example, the federal funds rate in the United States or the bank rate in the United Kingdom). These elements also recognize that over the long term monetary policy can influence nominal but not real (inflation-adjusted) variables; high inflation harms growth and the equitable distribution of income; and expectations and credibility significantly influence the effectiveness of monetary policy.

With experience, and as the inflation-targeting framework has been adopted by emerging market economies, it has tended to evolve in two particularly important respects. First, there has been a progressive increase in policy transparency and communication as the key means of providing public accountability, which underpins the operational independence of central banks and helps anchor inflation expectations. The main ways central banks communicate their targets include inflation or monetary policy reports two to four times a year, public statements following policy meetings, and, sometimes, publication of the minutes of policymaking meetings. Senior central bank officials also testify before legislatures. In general, central banks have become increasingly active in a much broader range of public communication activities than in the past.

Second, central banks have generally pursued a flexible form of inflation targeting. Rather than focusing on achieving the inflation target at all times, the approach has emphasized achieving the target over the medium term-typically over a two- to three-year horizon. This...