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Governor Frederic S. Mishkin

At the Princeton University Center for Economic Policy Studies Dinner, New York, New York
April 3, 2008

Central Bank Commitment and Communication
One of the things I often tell my 25-year-old son is, "Keep your options open." In effect, this means
that today he should make the best decision possible using the information he has at hand, and when
tomorrow comes he should reconsider all of his options, and again the next day, and so on. In the
terminology of economists, this strategy is usually referred to as "dynamic optimal policy under
discretion." And the idea of complete discretion may sound like a great idea--after all, why should
you restrict your choices? Nevertheless, in the context of central banking, the modern science of
monetary policy indicates that a discretionary approach can lead to poor economic outcomes.1
Therefore, in my remarks today, I would like to explain how a commitment to keeping inflation low
and stable can help foster the stability of economic activity as well as the stability of prices. After
analyzing the pitfalls of discretion and the benefits of a firm commitment to a nominal anchor, I will
discuss the role of central bank communication in promoting this commitment. I will then illustrate
these conceptual principles by considering the experiences of other central banks that have adopted
explicit numerical inflation objectives.
As usual, these remarks reflect only my own views and are not intended to reflect those of the
Federal Open Market Committee or of anyone else associated with the Federal Reserve System.2
Pitfalls of Discretionary Monetary Policy
Starting in the 1970s, the economics profession began to recognize that the evolution of economic
activity and inflation--and hence the design of optimal monetary policy--depends crucially on how
households, firms, and financial market investors form their expectations regarding the future course
of policy.3 This recognition of the central role of expectations in macroeconomic outcomes led to
the discovery of the time-inconsistency problem, a concept that sounds highfalutin but is actually
quite intuitive.4
This problem arises whenever the possibility of short-run gains creates a temptation to renege on an
existing plan, even though following that plan would produce a better outcome over the longer run.
In essence, if a good long-run plan will not be followed consistently over time because the short-run
gains of deviating from the plan are too tempting, then that plan is said to be time-inconsistent. In
such a setting, the time-consistent policy is to reoptimize every period, whereas the preferable
alternative would be to establish a firm commitment to the optimal long-run plan.
To take a common example that illustrates the time-inconsistency problem, someone may make a
New Year’s resolution about starting a diet. At some point thereafter, however, it becomes hard to
resist having a little bit of Rocky Road ice cream, and then a bit more, and pretty soon the weight
begins to pile back on.
The time-inconsistency problem arises in the context of monetary policy, because there is a
temptation to give a short-run boost to economic output and employment by pursuing a course of
policy that is more expansionary than firms or workers had initially expected.5 Nevertheless, if the

economy is already at full employment, then this boost is merely transitory: As economic activity
rises above its sustainable level, wages and prices begin to rise, and the private sector's inflation
expectations start to pick up. Of course, the central bank must eventually remove the policy stimulus
to avoid a continuous upward spiral of inflation. At that point, economic activity drops back to a
sustainable level. However, inflation settles in at a permanently higher rate because prospects of
future monetary expansions become embedded in expectations, and hence in wage and price
adjustments, and the higher average inflation rate generates undesirable economic distortions.6
Thus, failing to address the time-inconsistency problem poses the risk of ending up with a higher
average inflation rate, with detrimental long-run consequences for economic efficiency and the
general standard of living.
As my mother often told me when I was growing up, "The road to hell is paved with good
intentions." Similarly, discretionary monetary policy, even though well intended, can lead to poor
economic outcomes.
Benefits of a Firm Commitment to a Nominal Anchor
How can a central bank overcome the time-inconsistency problem? The answer is to establish a firm
commitment to a nominal anchor--that is, to ensure that inflation remains low and stable over time.
In a speech that I gave last week, I highlighted the merits of specifying an inflation objective in
terms of a specific numerical value.7 With an explicit numerical inflation objective, the central
bank's strategy is aimed at keeping economic activity close to a sustainable growth path and at
maintaining a low and stable inflation rate. Such a commitment ensures that the central bank resists
the temptation to pursue short-run expansionary policies that are inconsistent with the long-run
goals of price stability and maximum sustainable employment.
A strong commitment to an explicit numerical inflation objective has other significant benefits.
First, the long-run inflation expectations of households and firms are a key factor in determining the
actual behavior of inflation.8 In the absence of a firm nominal anchor, these expectations may
wander over time as the private sector revises its assessment of the rate at which inflation is likely to
settle down, and those movements in long-run inflation expectations can generate pressure on the
current inflation rate. Thus, by establishing a transparent and credible commitment to a specific
numerical objective, monetary policy can provide a firm anchor for long-run inflation expectations,
avoiding such pressures and thereby directly contributing to the objective of low and stable
inflation. Moreover, such a commitment can play an important role in minimizing the risk of
“inflation scares”--that is, episodes in which longer-term inflation expectations jump sharply in
response to specific macroeconomic developments or monetary policy actions.9
Second, as I emphasized in a speech in late February, establishing a firm commitment to a nominal
anchor can help stabilize output and employment.10 Specifically, to counter a contractionary
demand shock, the monetary authorities need to reduce the short-run nominal interest rate; however,
the effectiveness of such a policy action may be hindered if long-run inflation expectations are not
firmly anchored. For example, if the private sector becomes less certain about the longer-run
inflation outlook, then an increase in the inflation risk premium could boost longer-term interest
rates by more than the increase in expected inflation. The higher inflation risk premium would place
upward pressure on the real costs of long-term financing for households and businesses (whose debt
contracts are almost always expressed in nominal terms) and hence might partially offset the direct
monetary stimulus. Thus, a central bank commitment that firmly anchors long-run inflation
expectations can make an important contribution to the effectiveness of the central bank’s actions
aimed at stabilizing economic activity in the face of adverse demand shocks.
Third, a strong commitment to an explicit inflation objective provides the central bank with greater
flexibility to respond decisively to adverse demand shocks. Such a commitment helps ensure that an
aggressive policy easing is not misinterpreted as signaling a shift in the central bank's inflation
objective, and thereby minimizes the possibility that inflation expectations could move upward and
lead to a rise in actual inflation. A strong nominal anchor can be especially valuable in periods of
financial market stress; at such times, prompt and decisive policy action may be required to prevent

the financial market disruption from causing a severe contraction in economic activity that could
further exacerbate uncertainty and financial market stress, leading to a further deterioration in
macroeconomic activity, and so on.11 Thus, by providing the central bank with greater flexibility in
mitigating the risk of such an adverse feedback loop, the strong commitment to an explicit inflation
objective can play an important role in promoting financial stability as well as the stability of
economic activity and inflation.
Fourth, a strong nominal anchor can help minimize the effects of an adverse cost shock, such as a
persistent rise in the price of energy. Generally speaking, such shocks tend to result in weaker
economic activity as well as higher inflation. However, when longer-term inflation expectations are
firmly anchored, an adverse cost shock is likely to have only transitory effects on actual inflation;
hence, there may be no need to raise interest rates aggressively to keep inflation from moving
upward. Thus, the commitment to a nominal anchor can help reduce output and employment
fluctuations that impose unnecessary hardship on workers and, more broadly, the economy.
The bottom line is that a transparent and credible commitment to an explicit numerical inflation
objective can provide significant benefits in facilitating the central bank's task of stabilizing both
economic activity and inflation as well as fostering the stability of the financial system.
The Role of Central Bank Communication
Although a strong commitment to a nominal anchor is associated with significant benefits,
establishing and maintaining such a commitment tends to be easier said than done. After all, my
discussion of the time-inconsistency problem indicates that there are always pressures to renege on
that commitment. Here I will argue that central bank communication to increase transparency and
accountability can play a key role in helping central banks maintain a strong commitment to a
nominal anchor.
The public announcement of an explicit numerical inflation objective increases the accountability of
a central bank and therefore promotes the monetary authority's commitment to delivering low and
stable inflation. As put by a former governor of the Bank of Canada, such objectives give the public
a "precise yardstick for measuring how [the central bank] is doing."12 The credibility of the central
bank may rise over time as the public comes to appreciate its success in delivering inflation
outcomes consistent with its stated numerical objective. Similarly, the temptation to pursue policy
actions inconsistent with the objective--and hence renege on its commitment--may be diminished,
because large or persistent deviations of inflation from the stated goal would be observed by the
public and thus would be more likely to be called into question. As I argued in a speech last week,
accountability is further enhanced if the inflation objective is stated as a numerical value rather than
a range or comfort zone.13
But couldn't a numerical inflation objective be easily changed at the whim of the central bank or the
government? The time-inconsistency problem could then rear its ugly head, because raising the
numerical inflation objective could be used to justify more expansionary monetary policy to
generate higher employment and output in the short run. Although this temptation to renege on
keeping inflation low and stable might be present, the transparency of a public change in the
numerical inflation objective, which will subject it to public scrutiny and debate, makes it much
harder to engage in such opportunistic behavior. Unless an adjustment of the explicit inflation
objective is perceived to be driven by analytical considerations, it will be viewed as violating the
public's trust. The resulting loss of credibility on the part of the central bank (or the government)
could be devastating; hence, there are strong incentives not to change the inflation objective absent
sound technical reasons for doing so. Indeed, adjustments to the numerical inflation objective or the
inflation measure have rarely occurred in practice, and those adjustments have been consistent with
clear scientific reasoning.14
However, two important communication challenges arise in establishing a firm commitment to an
explicit numerical inflation objective. First, a central bank must make clear that this commitment
should not be regarded as implying that the central bank will continuously maintain inflation at the

specified rate or even that the inflation rate will always return to that rate over a fixed time horizon,
in the same way that one might pledge to lose 20 pounds in the next six or nine months. Given that
every economy is constantly buffeted by various shocks, it is generally neither feasible nor desirable
to try to keep inflation constant at some specific level. Thus, a commitment to keep inflation low
and stable should be interpreted in a probabilistic sense--that is, policy will act in a manner that
keeps inflation close to the inflation objective on average over time, and unusually large shocks may
result in more persistent deviations from this objective.
A second challenge stems from the fact that the optimal monetary policy under commitment to an
inflation objective is oriented toward minimizing variability in the real economy as well as keeping
inflation low and stable.15 As a consequence, when a given shock causes inflation to deviate
significantly from the numerical objective, the central bank must communicate how its policy
strategy will bring inflation back to this rate within a reasonable timeframe and how this strategy
will minimize fluctuations in output and employment over that horizon.16 For example, it is
generally desirable to reduce inflation gradually following an adverse cost shock in order to alleviate
the contractionary effects on the real economy.
These challenges highlight the extent to which central bank projections for economic activity and
inflation play an important role in maintaining a strong commitment to a nominal anchor.17 The
central bank must clarify how the economic outlook shapes its current policy actions as well as the
anticipated path of policy. Moreover, as the economy deviates from those forecasts, as it inevitably
does, the central bank must explain how policy will adapt to achieve the broad economic goals of
price stability and maximum sustainable employment.
Publicly announcing forecasts of inflation has the additional benefit of helping anchor inflation
expectations, thereby enhancing the effectiveness of monetary policy actions to stabilize economic
activity and lowering the economic cost of maintaining low and stable inflation. Another benefit of
publishing such forecasts is that discussion of the forecast can be used to highlight the analysis and
reasoning behind monetary policy decisions, which can help the public to better understand
monetary policy actions and strengthen the central bank’s credibility.
Although communication is a crucial element in establishing and maintaining a strong commitment
to a nominal anchor, with its attendant benefits, there are, of course, other elements as well. Even if
a central bank recognizes that a policy geared solely toward near-term economic activity will lead to
poor outcomes--high inflation with lower economic growth--it still may not be able to commit to a
strong nominal anchor and avoid the time-inconsistency problem, because special interests may try
to apply pressure on the central bank to boost employment in the short term through an overly
expansionary monetary policy.18
How can the central bank be insulated from short-run pressures to pursue expansionary policy at the
expense of high inflation? There is a broad international consensus that the central bank should have
full authority to determine the short-run setting of its policy instruments, without any external
interference.19 In addition, I believe that central bank communication is crucial in promoting public
support for maintaining low and stable inflation. Indeed, in a democratic society, every government
agency is ultimately accountable to the public, and the establishment of transparent objectives and
of a clear policy strategy plays an essential role in facilitating that accountability.
The old adage correctly states that "Actions speak louder than words," and, clearly, just announcing
an objective for inflation does not mean anything unless the actual policies pursued by the monetary
authorities are consistent with the objective. Words, however, do matter if those words help ensure
that the appropriate policy actions will be taken and strengthen the public's confidence that the
central bank will continue to act in a manner consistent with its long-run objectives. As I have
argued here, the increase in transparency and accountability, which results from clear
communication about inflation objectives and about how monetary policy will be conducted to
achieve these objectives, creates stronger incentives for central banks to avoid the pursuit of shortrun overly expansionary policies. This approach also helps establish a credible commitment to

pursuing policies that keep inflation under control and economic activity growing on a sustainable
The International Experience
My discussion so far has been pretty theoretical. But one might reasonably ask whether
communication about inflation objectives and about how monetary policy is conducted to achieve
these objectives actually helps strengthen the commitment to fostering low and stable inflation, and
thereby produces better economic outcomes. More specifically: Does communication of inflation
objectives lead to increased public support for the central bank? Improved inflation performance?
More firmly anchored inflation expectations?
Over the past two decades, most of the major foreign central banks have adopted frameworks which
have the overriding objective of bolstering public confidence that policymakers will act to keep
inflation low and stable. While self-declared "inflation targeters" are the most prominent in this
regard, other central banks also have introduced explicit inflation objectives of some kind, generally
in the form of a preferred inflation point or range.20 To address the questions that I listed earlier, I
will draw lessons from the international experience with explicit numerical inflation objectives,
while deferring further consideration of the United States until the conclusion of these remarks.
Central Bank Independence. I have already noted that increased central bank independence helps
support a commitment to a strong nominal anchor and thus should lead to better inflation
performance. Evidence supports the conjecture that macroeconomic performance is improved when
central banks are more independent. For example, when central banks in industrialized countries are
ranked according to the degree of legal independence of the central bank, those countries with the
highest degree of central bank independence are found to have the best inflation performance.21
I have also argued that adopting an explicit objective can help strengthen the accountability of
monetary policy actions and hence may promote public support for the operational independence of
the central bank. Although there has been a pronounced trend toward increased central bank
independence at the same time that monetary policy frameworks have adopted explicit inflation
objectives, it would be unwarranted to claim that this correlation implies causation from adoption of
explicit inflation objectives to central bank independence. However, this is where case studies can
help us.
One example that illustrates how having an explicit inflation objective encouraged public support
for stabilizing inflation and for the independence of the central bank occurred in Canada in 1996. At
that time, there was an important public debate about whether monetary policy was excessively
contractionary.22 In this case, the existence of an explicit inflation objective channeled that debate
into a substantive discussion over what should be the appropriate target for inflation, with both the
Bank of Canada and its critics obliged to make explicit their assumptions and estimates of the costs
and benefits of different levels of inflation. Indeed, the debate, as well as the Bank of Canada's
record and responsiveness to that debate, led to increased support for the Bank, with the result that
criticism of the Bank and its conduct of monetary policy became much less of a political issue.
Another interesting example, which I do not have time to discuss in detail here, occurred with the
granting of operational independence to the Bank of England in May 1997 after it had adopted an
explicit numerical inflation objective.23 In explaining the decision to grant operational independence
to the Bank of England, the government specifically pointed to the Bank's successful performance in
providing forecasts and clear explanations of the likely effects of a range of policy alternatives,
thereby increasing accountability and making the central bank more responsive to political
Inflation Outcomes. The adoption of a monetary policy framework with an explicit inflation
objective has hinged on the belief that such a framework ultimately delivers better inflation
outcomes. Thus, it is legitimate to inquire whether inflation outcomes in the economies that have
adopted such frameworks have been in line with the stated objectives.

Chart 1 displays the inflation objective and the relevant measure of realized inflation in a sample of
industrialized economies. Overall, the economies that adopted explicit inflation objectives have
experienced substantial improvements in their inflation performance; indeed, in each case the
central bank has been largely successful at keeping inflation in line with the stated objective,
sometimes even more than might have been anticipated when establishing that objective.24 Of
course, inflation has occasionally deviated from the objective, as one would expect from the fact
that every economy is continuously buffeted by various sorts of shocks. Nonetheless, these inflation
deviations have been relatively small and transitory by historical standards. Most important, there is
little evidence of a systematic upward bias in inflation, which would arise if the central bank were
attempting to stimulate output beyond what would be consistent with maintaining low and stable
I also want to emphasize that this improvement in inflation performance has not been at the expense
of higher employment and output fluctuations; indeed, the variability of output and employment
fluctuations has generally declined in those economies where the central bank has maintained an
explicit inflation objective.25
Inflation Expectations. Economies with explicit numerical inflation objectives have (fortunately)
not been alone in enjoying relatively low and stable inflation over the past couple of decades;
indeed, in some cases, inflation was already low and stable prior to the adoption of the explicit
objective. It is thus legitimate to investigate whether the establishment of an explicit inflation
objective has had other measurable effects, particularly with regard to the anchoring of long-run
inflation expectations.26
Chart 2 presents realized inflation along with a survey-based measure of mean inflation expectations
at the two-year-ahead and six-to-ten-year-ahead horizons. The evidence supports the view that
medium- to long-term expectations have become well anchored around the official objectives. First,
survey-based measures of long-term inflation expectations have converged toward the official
inflation objective in all countries. This fact is consistent with central banks making credible, longterm commitments to pursuing their objectives, even in countries where the objective must be
renewed on a regular basis.
Moreover, surveys of professional forecasters in each of these economies reveal that, on average,
forecasters expect deviations in realized inflation to disappear within two years or less. In effect,
these forecasters anticipate that the central bank will take the policy actions necessary to ensure that
inflation lines up with the explicit objective over a reasonable time horizon. Econometric analysis of
financial market data also indicates that long-run inflation expectations are firmly anchored in each
of the economies in which the central bank has an explicit numerical inflation objective.27
In a speech last week, I argued that the science of monetary policy provides a strong rationale for
framing the inflation goal in terms of a specific point objective rather than a range or comfort
zone.28 My remarks today provide further elaboration about how the establishment of a firm
commitment to an explicit numerical inflation objective contributes to better outcomes for both
inflation and economic activity. First, I have explained the pitfalls of discretionary monetary policy
and the benefits of a strong commitment to a nominal anchor. Second, I have considered how
central bank communications promote such a commitment. Third, I have highlighted some key
lessons from the experiences of other major industrial economies that have adopted explicit inflation
Finally, you may have noticed that I haven’t said much about the United States in this speech.
Nevertheless, the principles emphasized in my remarks today and in last week's speech have
potentially important implications for the ongoing process of refining the Federal Reserve's policy
framework and of enhancing our communications. Indeed, as Chairman Bernanke has recently
indicated, our communication strategy is "a work in progress," and the Federal Reserve "will
continue to look for ways to improve the accountability and public understanding of U.S. monetary

policy making."29 I hope that these remarks will be helpful in contributing to the continuation of
that process.

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Economic Journal, vol. 108 (November), pp. 1795-809.
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25th Annual Monetary Conference, Washington, November 14.
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of Price Stability, Range and Point Inflation Targets, and the Anchoring of Long-Term Inflation
Expectations," in O. Issing, ed., Background Studies for the ECB’s Evaluation of its Monetary
Policy Strategy (1.82 MB PDF). Frankfurt: European Central Bank, pp. 43-90.
Cukierman, Alex (1993). "Central Bank Independence, Political Influence and Macroeconomic
Performance: A Survey of Recent Development," Cuadernos de Economía, vol. 30 (no. 91), pp.
_________ (2006). "Central Bank Independence and Monetary Policy Making Institutions: Past,
Present, and Future," Journal Economía Chileña, vol. 9 (April), pp. 5-23.
Debelle, Guy, and Stanley Fischer (1994). "How Independent Should a Central Bank Be?" in Jeffrey
C. Fuhrer, ed., Goals, Guidelines, and Constraints Facing Monetary Policymakers, Federal Reserve
Bank of Boston Conference Series No. 38. Boston: Federal Reserve Bank of Boston, pp. 195-221.
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Forder, James (2000). "Central Bank Independence and Credibility: Is There a Shred of Evidence?"
International Finance, vol. 3 (April), pp. 167-85.

Goodfriend, Marvin (1993). "Interest Rate Policy and the Inflation Scare Problem: 1979-1992 (636
KB PDF)," Federal Reserve Bank of Richmond, Economic Quarterly, vol. 79 (Winter), pp. 1-24.
Gürkaynak, Refet S., Andrew Levin, and Eric T. Swanson (2006). "Does Inflation Targeting Anchor
Long-Run Inflation Expectations? Evidence from Long-Term Bond Yields in the U.S., U.K., and
Sweden," Centre for Economic Policy Research Discussion Paper 5808. London: Centre for
Economic Policy Research, August.
King, Mervyn (2004). "The New Inflation Target (108 KB PDF)," speech delivered at the
Birmingham Forward/CBI Business Luncheon, Birmingham, United Kingdom, January 20.
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1. Mishkin (2007c) provides extensive discussion of the modern science of monetary policy and its
implications for the design and communication of the policy framework. Return to text
2. I would like to thank Spencer Dale, Christopher Erceg, Etienne Gagnon, Linda Kole, Andrew
Levin, and Ricardo Nunes for assistance and helpful comments in preparing this speech. Return to
3. This change in views occurred as a result of the so-called rational expectations revolution, which
was launched by a series of remarkable papers by Nobel Prize-winner Robert Lucas (1972, 1973,
1976). Return to text
4. The time-inconsistency problem was first outlined in papers by Kydland and Prescott (1977) and
Calvo (1978). Return to text
5. Barro and Gordon (1983) first described the time-inconsistency problem as it applied to monetary
policy. Return to text
6. As described in Mishkin (2008c), a higher average inflation rate tends to generate distortions in
relative prices, a reduction in the level of investment in physical capital, and a decline in privatesector holdings of currency and other non-interest-bearing financial assets. Return to text
7. Mishkin (2008c). Return to text
8. Mishkin (2007a). Return to text
9. Goodfriend (1993). Return to text
10. Mishkin (2008b). Return to text

11. Mishkin (2008a). Return to text
12. Dodge (2002). Return to text
13. Mishkin (2008c). Return to text
14. Two cases are worth noting here. First, the New Zealand government raised the upper bound of
the Reserve Bank of New Zealand's inflation band by 1 percentage point in 1996 (from 2 percent to
3 percent) and raised the lower bound by 1 percentage point in 2002 (from 0 percent to 1 percent);
these changes were consistent with the science of monetary policy, which had reached a consensus
that allowing inflation to remain very close to zero could have detrimental consequences for the
economy (Mishkin, 2008c). Second, the Bank of England's inflation objective was modified in late
2003, establishing a target of 2 percent for the consumer price index (CPI) that replaced the previous
target of 2-1/2 percent for the retail price index excluding mortgage interest (RPIX). In that case, as
noted by the Governor of the Bank of England, there were significant conceptual reasons for
switching to the RPIX as a measure of U.K. inflation, while the downward adjustment of 1/2
percentage point in the numerical objective reflected the average magnitude of deviations between
CPI inflation and RPIX inflation over the previous decade or so (King, 2004). Return to text
15. Mishkin (2007b). Return to text
16. Svensson (1997). Return to text
17. Indeed, the Federal Reserve has published quantitative forecasts for several key macroeconomic
variables (output growth, unemployment, and inflation) as part of its semiannual reports to the
Congress since 1979. Several months ago, the Federal Reserve enhanced its communications by
publishing these forecasts on a quarterly basis, lengthening the horizon of the projections, and
providing additional quantitative and qualitative information (Bernanke, 2007; Mishkin, 2007d).
Return to text
18. Almost two centuries ago, British economist David Ricardo summarized the argument for
granting operational independence to the central bank: "It is said that Government could not be
safely entrusted with the power of issuing paper money; that it would most certainly abuse it.…
There would, I confess, be great danger of this if Government--that is to say, the Ministers--were
themselves to be entrusted with the power of issuing paper money" (Ricardo, 1823). Return to text
19. For an example of how the time-inconsistency problem can be modeled as resulting from
political pressure, see Mishkin and Westelius (2006). Independence to set policy instruments also
insulates the central bank from the myopia that can be a feature of the political process. Instrument
independence thus makes it more likely that the central bank will be forward-looking and adequately
allow for the long lags from monetary policy actions to inflation in setting its policy instruments.
Return to text
20. I discussed the relative merits of inflation objectives stated as points or ranges in Mishkin
(2008c). Return to text
21. Further analysis and discussion is given by Alesina and Summers (1993), Cukierman (1993),
and Debelle and Fischer (1994); Forder (2000) and Cukierman (2006) have surveyed the more
recent literature on central bank independence. Return to text
22. This debate was triggered by a speech given by the president of the Canadian Economic
Association. For further discussion of this episode, see Bernanke and others (1999). Return to text
23. Until May 1997, the setting of the monetary policy instrument had been determined by the
government, not by the Bank of England. At that point, the newly appointed Chancellor of the
Exchequer, Gordon Brown, announced that the Bank of England would henceforth have the
responsibility for setting both the base interest rate and short-term exchange-rate interventions. For

more discussion of this episode, see Mishkin and Posen (1997) and Bernanke and others (1999).
Return to text
24. The following anecdote provides a measure of the extent to which some policymakers were
pleasantly surprised by their central bank's success in keeping inflation in line with its objective.
The Governor of the Bank of England must write an open letter to the Chancellor of the Exchequer
when inflation deviates from the official target by more than 1 percentage point. About a year after
the Bank of England was granted operational independence, the Bank's chief economist wrote that
"[even] if inflation shocks were to disappear entirely, the continued presence of demand shocks
would imply that [open letters] would still be triggered more than 40 percent of the time" (Bean,
1998). A decade later, inflation has remained within 1 percentage point of the target in all but a
single month, or less than 1 percent of the time. Return to text
25. See the empirical analysis and discussion of Fatás, Mihov, and Rose (2007) and Mishkin and
Schmidt-Hebbel (2001, 2007). Return to text
26. I will spare the audience a thorough discussion of the methodological issues involved in the
measurement of inflation expectations. Some recent work on the topic was presented at the
Conference on Price Measurement for Monetary Policy, hosted by the Federal Reserve Bank of
Dallas on May 24-25, 2007. Return to text
27. See Castelnuovo, Altimari, and Rodriguez-Palenzuela (2003); Levin, Natalucci, and Piger
(2004); and Gürkaynak, Levin, and Swanson (2006). There is also some evidence that the dispersion
of inflation expectations may decrease with adoption of explicit inflation objectives. Mankiw, Reis,
and Wolfers (2003) have shown that simple survey statistics, such as the mean or median inflation
expectations, can sometimes hide substantial cross-sectional dispersion in survey responses. If a
central bank's credibility in meeting the inflation objective truly increases over time, one should then
observe less disagreement among inflation forecasters. The international evidence on this aspect is
unfortunately scant due to limited data availability. Beechey, Johannsen, and Levin (2007) recently
showed that the cross-sectional dispersion of long-run inflation expectations in the European Central
Bank (ECB) Survey of Professional Forecasters, as measured by the standard deviation, has more
than halved since the ECB, with its explicit inflation objectives, was launched in 1999. Although
this evidence cannot be used directly to measure the impact that the adoption of an explicit inflation
objective has on the dispersion of inflation expectations, it nevertheless suggests that there are
additional benefits to increasing a central bank’s credibility. Return to text
28. Mishkin (2008c). Return to text
29. Bernanke (2007). Return to text

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