Board of Governors of the Federal Reserve System (U.S.), 1935- and Gramlich, Edward M. "Inflation Targeting." Remarks before the Charlotte Economics Club, Charlotte, North Carolina, January 13, 2000, https://fraser.stlouisfed.org/title/914/item/35486, accessed on May 4, 2025.

Title: Inflation Targeting : Remarks before the Charlotte Economics Club, Charlotte, North Carolina

Date: January 13, 2000
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image-container-0 Remarks by Governor Edward M. Gramlich Before the Charlotte Economics Club, Charlotte, North Carolina January 13, 2000 Inflation Targeting At one time or another, opinions on how central banks should operate have focused on fixing exchange rates, stabilizing the rate of growth of the money supply, smoothing the growth of nominal income, or setting short-term interest rates through an instrument rule. But lately both academic economists and central bankers have become enamored of a new procedure that may have more staying power than these other approaches and that has certainly been more widely adopted around the world. Called inflation targeting, this new procedure essentially commits a country's central bank to hit an inflation target, usually expressed as a low, positive rate of inflation subject to some margin of error and some allowance for outside price shocks. New Zealand was the first country to adopt a formal inflation targeting regime back in 1990. It was soon followed by Canada, the United Kingdom, Sweden, and Australia. The European Central Bank at least alludes to inflation targeting in its strategy statements, as do many countries in eastern Europe that aspire to join the European Union. At least ten emerging-market countries have adopted inflation targeting as a way to correct persistent inflation problems. In the last few months alone, Turkey, Switzerland, and South Africa have announced that they are switching to inflation targeting. When tallied up, the number of countries on either a formal or an informal inflation-targeting regime now approaches thirty. Perhaps more meaningfully, there seems to be no country that has first tried inflation targeting and then abandoned it. One apparent holdout is the United States. While U.S. central bankers have often stressed the paramount importance of controlling inflation, the United States has never adopted a formal inflation target or an inflation-targeting regime. The Federal Reserve operates under the Federal Reserve Act, which requires the Fed to try to achieve maximum employment along with price stability. But both in the academic community and in the halls of the Congress, there are advocates for change. In a series of articles and books, Bernanke, Laubach, Mishkin, and Posen (1999) have proposed that the United States adopt an explicit inflation-targeting regime. Senator Connie Mack has introduced a bill to this effect in the Congress, so far not adopted. Recognizing that the question of whether the United States should adopt inflation targeting is ultimately a congressional prerogative, one could still ask the normative question of whether the United States should go to inflation targeting. The question is difficult to answer. While inflation targeting seems to have been successful around the world, the preconditions for success may not be relevant for this country. Given the strong U.S. commitment to controlling inflation, in the end there may be little difference between the
image-container-1 way monetary policy already is practiced in the United States and the way it is practiced under the flexible, forward-looking inflation-targeting regimes followed by many countries. Finally, although one can find economic circumstances in which inflation targeting will work well, it is also possible to imagine circumstances in which even forward-looking, flexible inflation targeting may not work so well, some of these circumstances from the fairly recent past of the United States. Basic Aspects of Inflation Targeting Describing an inflation-targeting regime is straightforward. A country or its central bank commits to controlling inflation, with an explicit target rate and usually a tolerance band around this target rate. Obvious price shocks such as indirect taxes, commodity prices, or interest rates themselves are usually excluded in the calculation of inflation targets. Many inflation-targeting regimes permit flexibility for pursuing other goals, such as output stabilization, though the primary commitment of the central bank is clearly to control inflation. Given the lags in monetary policy, many regimes also are forward-looking, in the sense that the central bank operates not against current inflation but expected inflation in the near future. Three rationales normally are given for the adoption of inflation-targeting regimes: The provision of a nominal anchor for policy, transparency, and credibility. A nominal anchor may be required if countries permit their exchange rates to vary and if they do not target either the growth of monetary quantities or nominal income. Governments or their central banks may need such an anchor to stabilize inflation, and they can generate the anchor by announcing an inflation target and then doing what they must do to hit that target. Such an approach would also lead to more transparent monetary policies, as economic actors would better understand the goals of monetary authorities. To the extent that monetary authorities can hit their target, central banks would also gain credibility, which many need after years of inflation. The ideals of transparency and credibility certainly have democratic value in their own right, but they may also pay off in narrower economic terms. It is commonly argued that inflationary expectations are a key aspect of the inflation process. In lowering inflationary expectations, inflation targeting can itself help reduce inflationary pressures. One can also rationalize inflation targeting through another form of economic reasoning. Some years ago many believed, along with Milton Friedman, that stabilizing the growth of the money supply would lead to stable prices. But this approach is now generally discredited because shocks in the demand for money and an unstable transmission mechanism imply that stable growth of monetary aggregates could lead to quite unstable behavior for prices and real incomes. The next step was to follow Bennett McCallum (1988) and avoid inappropriate responses to shocks in the demand for money by having the central bank simply stabilize nominal income growth. But again, if there were shocks in this nominal income growth, say productivity shocks, stabilizing nominal income growth would not necessarily stabilize prices. The same productivity shocks have led to difficulties with the instrument rule proposed by John Taylor (1993), which requires either a predictable rate of growth of potential output or a predictable natural rate of unemployment. As these other procedures for conducting monetary policy have run into difficulty, academic economists have increasingly drifted to the straightforward view of Bernanke, Laubach, Mishkin, Posen and many others that, if central banks want to stabilize prices, they should just do that by inflation targeting.
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Date: January 13, 2000
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