House of Paine

" inflation targeting ' explained by :Barnanke

to replace greensperm 


first there's
          feldstein
then there's

        Mr B 


heres Mr B's  brain 
   displayed on paper



========================================


One of the more interesting developments 
in central banking 
in the past dozen years or so 
has been the increasingly
 widespread adoption 
of the monetary policy framework 
known as inflation targeting.


The approach evolved gradually 
from earlier monetary policy strategies
 that followed the demise
 of the Bretton Woods fixed-exchange-rate system

most directly, I believe, 
from the practices of Germany's Bundesbank 
and the Swiss National Bank 
during the latter part 
of the 1970s and the 1980s. 

For example, the Bundesbank, 
though it conducted short-term policy
 with reference to targets 
for money supply growth,
 derived those targets each year
 by calculating the rate of money growth
 estimated to be consistent 
with the bank's long-run 
desired rate of inflation,
 normally 2 percent per year.

 Hence, the Bundesbank 
indirectly targeted inflation,
 using money growth 
as a quantitative indicator 
to aid in the calibration
 of its policy. 

Notably, the evidence suggests that,
 when conflicts arose between
 its money growth targets
 and inflation targets,
 the Bundesbank generally chose 
to give greater weight to
 its inflation targets 

The inflation-targeting approach
 became more explicit 
with the strategies adopted 
in the early 1990s 
by a number of pioneering central banks, 
among them the Reserve Bank of New Zealand, 
the Bank of Canada, 
the Bank of England, 
Sweden's Riksbank,
and the Reserve Bank of Australia.
 Over the past decade, 
variants of inflation targeting 
have proliferated, 
with newly industrialized 
and emerging-market economies 
(Brazil, Chile, Israel, Korea,
 Mexico, South Africa, 
the Philippines, and Thailand among others) 
being among the most enthusiastic initiates.

 Most recently, this policy framework 
has also been adopted 
by several transition economies,
 notably the Czech Republic,
 Hungary, and Poland.2 Central banks 
that have switched to inflation targeting
 have generally been pleased 
with the results they have obtained.

 The strongest evidence
 on that score is that,
 thus far at least,
 none of the several dozen adopters
 of inflation targeting
 has abandoned the approach.3 

As an academic interested 
in monetary policy,
 several years ago
 I became intrigued by inflation targeting 
and went on to co-author a book 
and several other pieces
about this approach.4 

As I continue to follow developments 
in the area, 
I must say, however,
 that discussions of inflation targeting
 in the American media 
remind me of the way some Americans 
deal with the metric system
they don't really know
 what it is,
but they think of it as foreign,
 impenetrable, and possibly slightly subversive.

 So, in the hope of cutting through some of the fog,
 today I will offer my own,
 perhaps somewhat idiosyncratic,
 view of inflation targeting 
and its potential benefits,
 at least in what I consider
 to be its best-practice form.5

 I will also try to dispel
 what I feel are a few misconceptions
 about inflation targeting 
that have gained some currency.

 Finally, I will end with a few words,
 and one modest suggestion,
 about the implications of the experience 
with inflation targeting 
for the practice of monetary policymaking 
at the Federal Reserve.6 

My main objective today, however, 
is to clarify, not to advocate. 
Of course, my comments today 
reflect my own views
 and do not necessarily reflect 
those of my colleagues 
at the Federal Reserve Board 
or on the Federal Open Market Committee. 

Best-Practice Inflation Targeting: One View 

Although inflation targeting 
has a number of distinguishing features
the announcement of a quantitative target 
for inflation being the most obvious
capturing the essence of the approach
 is not entirely straightforward.

 The central banks that call themselves 
inflation targeters,
 as well as the economies they represent,
 are a diverse group indeed,
 and (not surprisingly) 
institutional and operational features differ
 Moreover, many central banks 
that have not formally adopted 
the framework of inflation targeting
 have clearly been influenced
 by the approach 
(or, if you prefer, 
the same ideas and trends 
have influenced both inflation-targeters 
and non-inflation-targeters).

 For example, over the past twenty years,
 the Federal Reserve,
though rejecting the inflation-targeting label,
 has greatly increased 
its credibility for maintaining
 low and stable inflation, 
has become more proactive
 in heading off inflationary pressures,
 and has worked hard 
to improve the transparency
 of its policymaking process
all hallmarks of the inflation-targeting approach

 In short,
 to draw a bright line 
between central banks practicing
 full-fledged inflation targeting 
and those firmly outside 
the inflation-targeting camp 
is more difficult 
than one might first guess
a fact, by the way, 
that substantially complicates economists'
 attempts to assess empirically
 the effects of this approach. 

Nevertheless, for expository purposes, 
I find it useful 
to break down the inflation targeting approach 
into two components:

(1) a particular framework
 for making policy choices,

 and 

2) a strategy for communicating 
the context and rationale 
of these policy choices 
to the broader public. 

Let's call these two components
 of inflation targeting 

the policy framework 

and 

the communications strategy,

. 

The policy framework of inflation targeting 

By the policy framework 
I mean the principles
 by which the policy committee 
decides how to set its policy instrument
 typically a short-term interest rate
 In an earlier speech,
 I referred to the policy framework 
that describes what I consider
 to be best-practice inflation targeting
 as constrained discretion.7

 Constrained discretion attempts 
to strike a balance between 
the inflexibility of strict policy rules 
and the potential lack of discipline
 and structure inherent 
in unfettered policymaker discretion. 

Under constrained discretion,
 the central bank is free to do its best
 to stabilize output and employment
 in the face of short-run disturbances,
 with the appropriate caution
born of our imperfect knowledge 
of the economy and of the effects 
of policy 
(this is the "discretion" part
 of constrained discretion).

 However, a crucial proviso is that,
 in conducting stabilization policy, 
the central bank must also maintain
 a strong commitment 
to keeping inflation
--and, hence, public expectations 
of inflation-
-firmly under control
 (the "constrained" part of constrained discretion). 


Because monetary policy 
influences inflation with a lag,
 keeping inflation under control 
may require the central bank 
to anticipate future movements 
in inflation and move preemptively.
 Hence constrained discretion 
is an inherently forward-looking policy approach. 



Although constrained discretion 
acknowledges the crucial role 
that monetary policy plays 
in stabilizing the real economy, 
this policy framework 
does place heavy weight 
on the proposition that maintenance
 of low and stable inflation 
is a key element--

perhaps I should say 
the key element--
of successful monetary policy.

 The rationale for this emphasis 
goes well beyond the direct benefits 
of price stability 
for economic efficiency and growth, 
important as these are.
 The maintenance of price stability
--and equally important, 
the development by the central bank 
of a strong reputation 
for and commitment to it
--also serves to anchor the private sector's 
expectations of future inflation. 
Well-anchored inflation expectations 
(by which I mean that the public 
continues to expect low and stable inflation
 even if actual inflation 
temporarily deviates 
from its expected level) 

not only make price stability
 much easier to achieve 
in the long term 
but also increase the central bank's
 ability to stabilize output and employment 
in the short run.

 Short-run stabilization
 of output and employment 
is more effective when inflation expectations 
are well anchored 
because the central bank 
need not worry that
, for example, a policy easing 
will lead counterproductively
 to rising inflation 
and inflation expectations 
rather than to stronger real activity. 

In my earlier speech, 
I gave the Great Inflation 
           of the 1970s in the United States 
as an example of what can happen 
when inflation expectations 
are not well anchored.
 Contrary to the belief 
in a long-run tradeoff 
between inflation and unemployment 
held by many economists in the 1960s,
 unemployment and inflation 
in the 1970s were both high and unstable.

 Even today conventional wisdom ascribes 
this unexpected outcome 
to the oil price shocks of the 1970s. 

Though increases in oil prices 
were certainly adverse factors,
 poor monetary policies 
in the second half of the 1960s
 and in the 1970s both facilitated 
the rise in oil prices themselves 
and substantially exacerbated 
their effects on the economy. 

Monetary policy contributed 
to the oil price increases 
in the first place 
by creating an inflationary environment 
in which excess nominal demand 
existed for a wide range
 of goods and services. 

For example, 
in an important paper,
 Barsky and Kilian (2001) noted 
that the prices 
of many industrial commodities 
and raw materials
 rose in the 1970s 
about the same time as oil prices,
 reflecting broad-based 
inflationary pressures.

 Without these general inflationary pressures,
 it is unlikely
 that the oil producers
 would have been able to make 
the large increases in oil prices "stick" 
for any length of time. 

Besides helping to make 
the oil price increases possible,
 the legacy of poor monetary policies 
also exacerbated the effects 
of the oil price increases 
on output and employment. 

When the oil price shocks hit,
 beginning in 1973,
 inflation expectations 
had already become very unstable,
 after several years 
of increased inflationary pressures 
and a failed program of price controls 
under President Nixon. 

Because inflation expectations 
were no longer anchored,
 the widely publicized oil price increases 
were rapidly transmitted 
into expectations
 of higher general inflation and,
 hence,
 into higher wage demands 
and other cost pressures.

 Faced with an unprecedented inflationary surge,
 the Fed was forced to tighten policy. 
As it turned out,
 the Fed's tightening was not enough
 to contain the inflationary surge 
but was sufficient to generate a severe recession. 

The upshot is that 
the deep 1973-75 recession
 was caused only in part
 by increases in oil prices per se.

 An equally important source 
of the recession 
was several years 
of overexpansionary monetary policy
 that squandered the Fed's credibility
 regarding inflation,

 with the ultimate result that
 the economic impact of the oil producers' actions 
was significantly larger
 than it had to be. 

Instability in both prices 
and the real economy 
continued for the rest of the decade, 
until the Fed under Chairman Paul Volcker
 re-established the Fed's credibility
 with the painful
 disinflationary episode of 1980-82. 

This latter episode 
and its enormous costs 
should also be chalked up 
to the failure to keep inflation 
and inflation expectations 
low and stable. 

In contrast to the 1970s, 
fluctuations in oil prices 
have had far smaller effects
 on both inflation and output
 in the United States
and other industrialized countries
 since the early 1980s. 

In part this more moderate effect 
reflects increased energy efficiency
 and other structural changes, 
but I believe the dominant reason 
is that the use of constrained discretion 
in the making of monetary policy
 has led to better anchoring 
of inflation expectations
 in the great majority of industrial countries.

 Because inflation expectations 
are now more firmly tied down,
 surges and declines in energy prices 
do not significantly affect
 core inflation 
and thus do not force 
a policy response to inflation 
to the extent they did 
three decades ago.

 Indeed, rather than leading to a tightening 
of monetary policy,
 increases in oil prices today 
are more likely to promote consideration 
of increased policy ease--
a direct and important benefit
 of the improved control of inflation. 

The communications strategy 
of inflation targeting 
The second major element 
of best-practice inflation targeting (in my view) 
is the communications strategy, 
the central bank's regular procedures
 for communicating with the political authorities,
 the financial markets,
 and the general public. 

In general,
 a central bank's communications strategy,
 closely linked to the idea of transparency,
 has many aspects and many motivations.

 Aspects of communication 
that have been particularly emphasized
 by inflation-targeting central banks 
are 

   1)  the public announcement of policy objectives 
(notably, the objective for inflation), 

    2)   open discussion of the bank's policy framework
 (including in some cases, 
but not all, a timeframe for achieving 
the inflation objective),

 and

   3)    public release of the central bank's forecast 
or evaluation of the economy 
(as reported, for example, 
in the Inflation Reports 
issued by a number of inflation-targeting central banks).



Why have inflation-targeting central banks 
emphasized communication
, particularly the communication
 of policy objectives,
 policy framework, 
and economic forecasts? 

In the 1960s,
 many economists were greatly interested 
in adapting sophisticated 
mathematical techniques 
developed by engineers
 for controlling missiles and rockets 
to the problem of controlling the economy. 

At the time,
 this adaptation of so-called 
stochastic optimal control methods 
to economic policymaking seemed natural;
 for like a ballistic missile, 
an economy may be viewed 
as a complicated dynamic system 
that must be kept on course, 
despite continuous buffeting 
by unpredictable forces. 

Unfortunately, macroeconomic policy 
turned out not to be rocket science! 

The problem lay in a crucial difference
 between a missile and an economy

--which is that,
 unlike the people who make up an economy, 
the components of a missile 
do not try to understand 
and anticipate the forces being applied to them.

 Hence, although a given propulsive force 
always has the same, predictable effect
 on a ballistic missile,
a given policy action--
say, a 25-basis-point cut 
in the federal funds rate--
can have very different effects 
on the economy,


 depending (for example)
 
on

 what the private sector infers
          from that action


1) about 
  likely future policy actions, 


2) about the information 
that may have induced the policymaker to act

3) about the policymaker's objectives
 in taking the action,
 

   and so on


 Thus, taking the "right" policy action--
in this case, 
changing the federal funds rate 
by the right amount 
at the right time--
is a necessary 
but not sufficient condition 
for getting the desired economic response.

 Most inflation-targeting central banks 
have found that effective communication policies 
are a useful way, in effect, 
to make the private sector a partner
 in the policymaking process. 


To the extent that it can explain 
its general approach,
 clarify its plans and objectives,
 and provide its assessment 
of the likely evolution of the economy,
 the central bank should be able 
to reduce uncertainty,
 focus and stabilize private-sector expectations
, and--with intelligence, luck, and persistence-
-develop public support
 for its approach to policymaking. 

Of course,
 as has often been pointed out, 
actions speak louder than words;
 and declarations by the central bank 
will have modest and diminishing value 
if they are not
 clear, coherent,
 and--most important--credible,
 in the sense 
of being consistently backed up 
by action. 



But agreeing 
that words must be consistently backed 
by actions 
is not the same as saying 
that words have no value.

 In the extreme,
 I suppose a central bank
 could run a "Marcel Marceau" monetary policy,
 allowing its actions 
to convey all its intended meaning.

 But common sense suggests 
that the best option 
is to combine actions with words
--to take clear, purposeful,
 and appropriately timed
 policy actions 
that are supported by coherent explanation
 and helpful guidance about the future. 

One objection
 that has been raised 
to the public announcement 
of policy objectives, 
economic forecasts, 
and (implicit or explicit) policy plans
 by central banks 
is that even relatively modest commitments 
along these lines
 may limit their flexibility 
to choose the best policies 
in the future.

 Isn't it always better 
to be more 
rather than less flexible?

 Shouldn't the considered judgment
 of experienced policymakers 
always trump rules,
 even relatively flexible ones,
 for setting policy? 

I agree that human judgment
 should always be the ultimate source
 of policy decisions 
and that no central bank should
--or is even able to--
commit irrevocably in advance
 to actions that may turn out to be
 highly undesirable.

 However, the intuition 
that more flexibility 
is always better than less flexibility 
is quite fallacious,
 a point understood long ago by Homer
, who told of how Ulysses 
had himself tied to the mast 
so as not to fall victim 
to the songs of the Sirens.

 More recently,
 the notion that more flexibility 
is always preferable 
has been pretty well gutted 
by modern game theory 
(not to mention modern monetary economics),
 which has shown in many contexts
 that the ability to commit in advance 
often yields better outcomes. 

For illustration 
of the potential benefits 
to policymakers
 of even modest self-imposed restrictions 
on flexibility,
 consider fiscal policy, 
which shares with monetary policy 
some of the same issues 
that arise when a group 
of shifting membership 
makes a series of policy decisions 
that have both short-run 
and long-run implications. 

In the short run, 
fiscal policymakers 
may have important
and legitimate reasons 
to depart from budget balance,
 sometimes even substantially--
for example, to appropriate funds 
to deal with a national emergency 
or to provide a stimulus package 
to assist economic recovery. 

In the long run, however,
 maintaining public confidence 
requires that fiscal policy 
be conducted in such a way 
that the ratio 
of national debt to GDP 
remains stable 
at a moderate level.

 Arguably, public confidence,
 and hence the ability 
of policymakers to use
 fiscal instruments aggressively 
to address short-term concerns, 
is enhanced by whatever legislative rules,
 guidelines, 
or procedures exist that
--however gently or firmly--
tend to compel the policymakers 
to bring the budget back toward balance,
 and the debt-GDP ratio
 back toward stability, 

after the crisis has passed. 
True, spending caps,
 comprehensive budget resolutions,
 mandatory long-term deficit projections,
 and similar provisions,
 to the extent that they are effective,
 may reduce at least a bit
 the flexibility of fiscal policymakers.

 But if intentionally yielding 
a bit of flexibility
increases public confidence 
in the long-run sustainability 
of the government's spending
 and tax plans
, fiscal policymakers may find 
that adopting these rules 
actually enhances 
their ability to act effectively 
in the short run. 

As with fiscal policy,
 public beliefs about how monetary policy 
will perform in the long run affect
 the effectiveness of monetary policy
 in the short run.

 Suppose, for example, 
that the central bank 
wants to stimulate a weak economy 
by cutting its policy interest rate.

 The effect on real activity 
will be strongest 
if the public is confident 
in the central bank's 
unshakable commitment to price stability,

 as that confidence 
will moderate any tendency 
of wages, prices, or long-term interest rates 
to rise today 
in anticipation 
of possible future inflationary pressures
 generated by the current easing of policy. 

Now the central bank's 
reputation and credibility 
may be entirely sufficient
 that no additional framework 
or guidelines are needed. 

Certainly, in general, 
the greater the inherited credibility
 of the central bank,
 the less restrictive need be
 the guidelines, targets, or the like
 that form the central bank's communication strategy.

 But credibility 
is not a permanent characteristic
 of a central bank; 
it must be continuously earned. 

Moreover, an explicit policy framework 
has broader advantages, 
including among others 

1) increased buy-in 
          by politicians and the public, 

2) increased accountability, 
reduced uncertainty,
 and greater intellectual clarity.

 Hence, 
though a central bank 
with strong credibility 
may wish to adopt a relatively 
loose and indicative set 
of guidelines 
for communication with the public,
 even such a bank may benefit 
from increasing its communication
 with the public and adding 
a bit of structure 
to its approach
 to making policy.

 From the public's perspective
, the central bank's commitment
 to a policy framework, 
including a long-run inflation target
 imposes the same kind of discipline 
and accountability 
on the central bank 
that a long-term commitment
 to fiscal stability places 
on the fiscal authorities. 


-----------------------------------------


Misconceptions about Inflation Targeting


I would like to turn now, briefly,
 to comment on a few key misconceptions 
about inflation targeting 
that have gained some currency
 in the public debate. 

Misconception #1: 

Inflation targeting involves 
mechanical, rule-like policymaking.

 As Rick Mishkin and I emphasized 
in our early expository article
 (Bernanke and Mishkin, 1997),
 inflation targeting is a policy framework,
 not a rule. 

If it is to be coherent and purposeful,
 all policy is made within some sort 
of conceptual framework;
 the question is the degree 
to which the framework is explicit.

 Inflation targeting provides 
one particular coherent framework
 for thinking about monetary policy choices 
which, importantly,
 lets the public in on the conversation.

 If this framework succeeds 
in its goals of anchoring inflation expectations,
 it may also make the policymaker's 
ultimate task easier.

 But making monetary policy 
under inflation targeting 
requires as much insight and judgment 
as under any policy framework; 
indeed, inflation targeting 
can be particularly demanding 
in that it requires policymakers
 to give careful,
 fact-based, and analytical explanations
 of their actions to the public. 

Misconception #2: 

Inflation targeting 
focuses exclusively on control of inflation 
and ignores output and employment
 objectives. 

Several authors
 have made the distinction
 between so-called "strict" inflation targeting, 
in which the only objective 
of the central bank is price stability,
 and "flexible" inflation targeting, 
which allows attention to
 output and employment as well.

 In the early days of inflation targeting,
 this distinction may have been a useful one,
 as a number of inflation-targeting
 central banks talked the language
 of strict inflation targeting 
and one or two came close t
o actually practicing it.

 For quite a few years now, however, 
strict inflation targeting 
has been without significant 
practical relevance.

 In particular, 
I am not aware of any real-world central bank 
(the language of its mandate notwithstanding) 
that does not treat 
the stabilization of employment and output 
as an important policy objective. 

To use the wonderful phrase 
coined by Mervyn King,
 the Governor-designate 
of the inflation-targeting Bank of England,
 there are no 
"inflation nutters" 
heading major central banks.
 Moreover, virtually all 
(I am tempted to say "all") 
recent research on inflation targeting 
takes for granted 
that stabilization of output and employment
 is an important policy objective 
of the central bank.

 In short, in both theory and practice,
 today all inflation targeting 
is of the flexible variety. 

A second, more serious, issue 
is the relative weight, or ranking,
 of inflation and unemployment 
(or, more precisely, the output gap)
 among the central bank's objectives.

 Countries differ in this regard,
 both in formal mandate
 and in actual practice.

 As an extensive academic literature shows,
 however, 
the general approach of inflation targeting 
is fully consistent with 
any set of relative social weights
 on inflation and unemployment;
 the approach can be applied
 equally well 
by "inflation hawks," 
"growth hawks,"
 and anyone in between.

 What I find particularly appealing 
about constrained discretion,
 which is the heart 
of the inflation-targeting approach,
 is the possibility of using it 
to get better results 
in terms of both inflation and employment. 


Personally, I subscribe unreservedly 
to the Humphrey-Hawkins dual mandate,
 and I would not be interested 
in the inflation-targeting approach
 if I didn't think 
it was the best available technology
 for achieving both sets 
of policy objectives 

Misconception #3: 
Inflation targeting is inconsistent 
with the central bank's obligation 
to maintain financial stability.

 Let me address this point 
in the context of the United States.
 The most important single reason 
for the founding of the Federal Reserve
 was the desire of the Congress 
to increase the stability 
of American financial markets,
 and the Fed continues to regard 
ensuring financial stability 
as a critical responsibility. 

(By the way, this is a reason 
to be nervous about the recent trend 
of separating central banking 
and financial supervision; 
I hope we have the sense 
not to do that here.)

 I have always taken it 
to be a bedrock principle
 that when the stability 
or very functioning 
of financial markets is threatened,
 as during the October 1987 stock market crash 
or the September 11 terrorist attacks,
 that the Federal Reserve 
would take a leadership role 
in protecting the integrity of the system.

 I see no conflict
 between that role 
and inflation targeting 
(indeed, inflation targeting 
seems to require 
the preservation of financial stability 
as part of preserving macroeconomic stability),

 and I have never heard a proponent
 of inflation targeting argue 
otherwise. 


--------------------------------------------


Inflation Targeting and the Federal Reserve 

As I noted earlier,
 the Federal Reserve,
 though rejecting any explicit affiliation
 with inflation targeting,
 has been influenced by many 
of the same ideas
 that have influenced self-described 
inflation targeters

 Increasingly greater transparency
 and more forward-looking,
 proactive policy
 are two examples
 of convergence in practice
 between the Fed and inflation-targeting central banks,
 and I think most would agree 
that both of these developments 
have been positive
 and have led to better outcomes.
 Most important,
 however, as I discussed 
in the earlier speech,
 under Chairman Volcker and Chairman Greenspan,
 the Fed has moved gradually toward 
a policy framework of constrained discretion

 In particular,
 through two decades 
of effort the Fed has restored
 its credibility
 for maintaining low and stable inflation,
 which--as theory suggests--
has had the important benefit 
of increasing the institution's
 ability to respond to shocks
 to the real economy.

 The acid test occurred in 2001, 
when the FOMC cut interest rates 
by nearly 500 basis points
 without any apparent adverse effect 
on inflation expectations. 

Given the Fed's strong performance 
in recent years, 
would there be any gains 
in moving further down the road 
toward inflation targeting? 

The most heated debates 
are said to occur on questions 
that are inherently impossible
 to prove either way,
 and I am afraid that
 this question gives rise 
to one of those debates,

 involving as it does 
counterfactual futures.
 Personally, though, 
I believe that U.S. monetary policy 
would be better in the long run 
if the Fed chose 
to make its policy framework
 somewhat more explicit.

 First, 

the Fed is currently 
in a good and historically rare situation
, having built a consensus 
both inside and outside the Fed 
for good policies.

 We would be smart 
to try to lock in this consensus 
a bit more 
by making our current procedures 
more explicit 
and less mysterious to the public.

 Second, making 
the Fed's inflation goals
 and its medium-term projections 
for the economy 
more explicit 
would reduce uncertainty 
and assist planning 
in financial markets 
and in the economy more generally.

 Finally, any additional anchoring
 of inflation expectations 
that we can achieve now 
will only be helpful in the future.

To move substantially further 
in the direction of inflation targeting,
 should it choose to do so,
 the Fed would have to take 
two principal steps:

 first,

to quantify (numerically, 
and in terms of a specific price index)
 what the Federal Open Market Committee means 
by "price stability",

 second,

 to publish regular medium-term projections
 or forecasts of the economic outlook,
 analogous to the Inflation Reports 
          published by
 both inflation-targeting central banks. 

Particularly now that we are
 in the general range of price stability,

 I believe that quantifying
 what the FOMC means by price stability 
would provide useful information
 to the public 
and lend additional clarity 
to the policymaking process.

Let me add a caveat however.
 Despite the potential long-run benefits 
of such a change,

 FOMC members may be concerned 
at this juncture
that the Congress and the public 
would misperceive the quantification 
of price stability
 as an elevation 
of the Fed's price stability objective
 above its employment objective
 in violation of the dual mandate
 even if that were in no way the intention.

 Although personally I have no doubt
 that quantification
 of the price stability objective
 is fully consistent
 with the current dual mandate,
 I also appreciate 
the delicate issues 
of communication raised by such a change.
 Realistically,
 this step is unlikely 
to occur without a good bit more public discussion
 I hope that my talk today 
contributes to that discussion 

The publication of medium-term forecasts 
does not raise nearly the same difficult
 political and communication issues 
that quantification 
of price stability may
 in my view,
 and so I propose it here
 as a more feasible short-term step

 The FOMC already releases 
(and has released since 1979)
 a range and a "central tendency" 
of its projections for nominal GDP growth,
 real GDP growth,
 PCE inflation,
 and the civilian unemployment rate
 twice each year,
 publishing them as part
 of the semiannual Monetary Policy Report 
to the Congress.
 These projections are actually quite interesting
 as they represent the views 
of Fed policymakers 
of the future evolution
 of the economy,
 conditional on what each policymaker views 
as the best path for future policy
 Two drawbacks of these projections 
as they now stand are that

 (1) they are sometimes not released 
for a number of weeks 
(the time between the FOMC meeting
 at which they are assembled 
and the Chairman's testimony to the Congress)

 and 

(2) the January projections cover only
 the remainder of the current year
 (the July projections cover 
the remainder of the current year
and all of the subsequent year). 


I think it would be very useful 
to detach these projections 
from the Monetary Policy Report
 and instead release them shortly after the meetings
 (in January and July) 
at which they are compiled.

 I would also suggest 
adding a second year of forecast 
to the January projection,
 to make it more parallel 
to the July projection 
as well as to the forecasts 
in the staff-prepared Greenbook. 

By releasing the projections 
in a more timely manner, 
and by adding a year to the January projection, 

the FOMC could provide 
quite useful information to the public.

 In particular,
 the FOMC projections would convey 
the policymakers'
 sense of the medium-term evolution
 of the economy,
 providing insight into
 both the Fed's diagnosis of economic conditions
 and its policy objectives.

 Ideally, the release of these projections
 also would provide occasions 
for Governors and regional Bank Presidents
 drawing on the expertise 
of their respective staffs
 to convey their individual views 
on the prospects for the economy 
and the objectives of monetary policy. 
----------------------

Conclusion 

Inflation targeting, 
at least in its best-practice form,
 consists of two parts:

 a policy framework 
of constrained discretion 

and 

a communication strategy 
that attempts to focus expectations 
and explain the policy framework 
to the public.

 Together, these two elements 
promote both price stability
 and well-anchored inflation expectations;

 the latter in turn
 facilitates more effective stabilization
 of output and employment. 

Thus, a well-conceived 
and well-executed strategy 
of inflation targeting 
can deliver good results 
with respect to output and employment
 as well as inflation. 

Although communication 
plays several important roles 
in inflation targeting
, perhaps the most important
 is focusing and anchoring expectations.

 Clearly there are limits 
to what talk can achieve; 
ultimately, 
talk must be backed up by action,
 in the form of successful policies.

 Likewise, for a successful 
and credible central bank 
like the Federal Reserve, 
the immediate benefits 
of adopting a more explicit communication strategy 
may be modest.
 Nevertheless,
 making the investment now 
in greater transparency
 about the central bank's 
objectives, plans, and assessments
 of the economy 
could pay increasing dividends
 in the future.


--------------------------------------------------------------------------------

Footnotes 

1. The interpretation of the Bundesbank
 as a proto-inflation targeter 
is not universally accepted.
 Certainly, 
the Bundesbank did not put
 the same emphasis 
on communication and transparency 
that modern inflation-targeting central banks do. 

2. Mishkin and Jonas (forthcoming) 
describe the experiences 
of the three transition economies
 with inflation targets.  

3. A few countries that used inflation targeting 
in the transition to European monetary union
 are a partial exception. 
The European Central Bank itself
 has an inflation objective
 (a ceiling of 2 percent) 
but does not refer to itself
 as an inflation-targeting central bank
 largely on the grounds that 
(officially, at least) 
it also puts some weight on money growth 
in its policy decisions

 As a newly created central bank 
presiding over a monetary union
 the ECB is unique in more fundamental ways as well; 
hence, the lessons from the ECB experience 
for the Federal Reserve 
and other established central banks
 may be somewhat limited.
 

4. See in particular Bernanke and Mishkin (1997)
 and Bernanke, Laubach, Mishkin, and Posen (1999). 

5. By focusing on what I call “best practice” inflation targeting,
 I must necessarily be somewhat subjective;
 but then my goal today is largely normative,
 not descriptive.  

6. For a more detailed exposition 
of the case for inflation targeting 
in the United States,
 see Goodfriend (forthcoming).  

7. Bernanke (2003).  

8. In some countries, 
improved transparency has accompanied 
greater central bank independence
 on the argument 
that more independent central banks 
must also provide enhanced accountability. 

9. I refer to these features
 as communication rather 
than as rules because 
they simply make public 
the elements of the policy framework,
 that is, constrained discretion.
 Even when the inflation target
 itself is set outside 
the central bank 
or 
by an outside agency 
with the cooperation 
of the central bank, 
for the most part 
inflation-targeting central banks
 themselves 
rather than outsiders 
(such as the legislature) 
are the principal enforcers
 of their own targets and procedures. 

“Self-enforced” inflation targets 
are the only case
 I will consider here. 

10. King (1997) appears to be the source 
of the phrase.  

11. Svensson (1999),
 who I believe coined the phrase 
“strict inflation targeting”,
 calls this point “uncontroversial.” 
Svensson’s paper and his related work
 also show in detail the consistency 
of inflation targeting with a dual mandate.  

12. A number of inflation-targeting central banks 
refer to inflation stabilization
 as the central bank’s 
“primary long-run objective.”
 At one level,
 this statement does not have much content 
because inflation 
is the only variable 
that central banks 
can control in the long run
 Its real import is to say that
 the central bank is responsible 
for long-run price stability,
 a statement that should be 
unobjectionable
 in any framework.  

13. Meyer (2001) draws a distinction 
between a hierarchical mandate,
 which subordinates other objectives 
to the price stability objective,
 and a dual mandate,
 which places price stability
 and employment objectives 
on equal footing. 

Like Meyer, I prefer the dual mandate formulation 
and find it to be fully consistent 
with inflation targeting. 
Formally, the dual mandate
 can be represented by a central bank
 loss function 
that includes both inflation and unemployment 
(or the output gap) 
symmetrically.  

14. Here is part of a verbal reply 
that I made to a commenter on a paper 
about inflation targeting
 and asset prices
 that Mark Gertler and I presented
 at the Fed’s Jackson Hole conference
 in August 1999,
 as published in the conference volume: 

“I want to correct the impression . . .
 that Mark and I are somehow 
against lender-of-last-resort activities,
 which is absolutely wrong. 
I have studied the Depression
 quite a bit in my career, 
and I think there are two 
distinguishing mistakes 
that the Federal Reserve made. 

The first 
was to allow 
a serious deflation, 
which an inflation targeting regime 
would not have permitted.

 And the second
was to allow 
the financial system 
to collapse,


 and I absolutely agree
 with,
 for example, 
what happened in October 1987 
and other interventions . . . 
One advantage of the inflation targeting approach
 as opposed, for example,
 to a currency board, 
is [that] it gives you considerably more scope
 for lender-of-last-resort activities.” 
(Federal Reserve Bank of Kansas City, 1999,
 p. 145)  

15. Bernanke (2003). Gramlich (2000) 
made a similar observation 
and cited empirical evidence.  

16. In principle, the Federal Reserve 
could also publish its estimate 
of the long-run growth potential 
of the U.S. economy,
 for symmetry with its estimate 
of price stability.
 Unfortunately, potential output growth 
tends to be variable 
and difficult to measure with precision.
 A deeper asymmetry arises 
from the fact that,
 unlike the long-run rate of inflation,
 the Federal Reserve cannot control,
 and thus cannot be held responsible for,
 the long-run economic growth rate


17. The Monetary Policy Report 
 is required by the Congress under Section 2B 
of the Federal Reserve Act
 The report is required to contain
 “a discussion of the conduct
 of monetary policy and economic developments 
and prospects for the future . . .” 
The projections may be interpreted 
as satisfying part of the requirement 
to provide the Federal Reserve’s view
 on prospects for the future.  

18. An alternative, 
suggested by Blinder et al. (2001),
 is to release a summary 
of the staff-prepared forecasts 
(the “Greenbook” forecasts).
 I think that option 
is worth considering
 but prefer focusing on the FOMC projections
 for now. 

The projections of the FOMC members 
draw heavily on the expertise
 of the Board staff,
 as well as the staff 
of the regional Banks,
 but they also reflect 
the policymakers’ personal views, 
which I think is important.
 Reporting policymakers’ projections
 rather than staff projections
 is in keeping with the practices
 of most other central banks.  

References

Barsky, Robert and Lutz Kilian (2001). "Do We Really Know That Oil Caused the Great Stagflation? A Monetary Alternative," in B. S. Bernanke and K. Rogoff, eds., Macroeconomics Annual, Cambridge, Mass.: MIT Press for NBER, pp. 137-82. 

Bernanke, Ben (2003). " 'Constrained Discretion' and Monetary Policy", Remarks to the Money Marketeers of New York University, February 3, www.federalreserve.gov. 

Bernanke, Ben, Thomas Laubach, Frederic Mishkin, and Adam Posen (1999). Inflation Targeting: Lessons from the International Experience. Princeton N.J.: Princeton University Press. 

Bernanke, Ben, and Ilian Mihov (1997). "What Does the Bundesbank Target?" European Economic Review, vol. 41, pp. 1025-53. 

Bernanke, Ben, and Frederic Mishkin (1997). "Inflation Targeting: A New Framework for Monetary Policy?" Journal of Economic Perspectives, vol. 11, pp. 97-116. 

Blinder, Alan, Charles Goodhart, Philipp Hildebrand, David Lipton, and Charles Wyplosz (2001). How Do Central Banks Talk? Geneva: International Center for Monetary and Banking Studies.

Federal Reserve Bank of Kansas City (1999). New Challenges for Monetary Policy: A Symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 26-28. 

Goodfriend, Marvin (forthcoming). "Inflation Targeting in the United States?" in B. Bernanke and M. Woodford, eds., Inflation Targeting. Chicago: U. of Chicago Press for National Bureau of Economic Research. 

Gramlich, Edward (2000). "Inflation Targeting." Remarks before the Charlotte Economics Club, January 13. 

King, Mervyn (1997). "Changes in U.K. Monetary Policy: Rules and Discretion in Practice." Journal of Monetary Economics, vol. 39 (June), pp. 81-97. 

Meyer, Laurence (2001). "Inflation Targets and Inflation Targeting," Remarks at the University of San Diego Economics Roundtable, July 17. 

Mishkin, Frederic and Jiri Jonas (forthcoming). "Inflation Targeting in Transition Economies: Experience and Prospects," in B. Bernanke and M. Woodford, eds., Inflation Targeting. Chicago: U. of Chicago Press for National Bureau of Economic Research. 

Svensson, Lars (1999). "Inflation Targeting as a Monetary Policy Rule". Journal of Monetary Economics, vol. 43 (June), pp. 607-54.