Missing the Mark: The Truth About Inflation Targeting

James K. Galbraith takes our book, Inflation Targeting: Lessons from the International Experience, as the jumping-off point for a screed against obsession with price stability ("The Inflation Obsession: Flying in the Face of the Facts," January/February 1999). He does Foreign Affairs readers a disservice by misrepresenting our argument and, as a result, leaves them uninformed about perhaps the most important current debate on the conduct of monetary policy.

DEMOLISHING A STRAW MAN

Inflation targeting -- and our "manifesto" in favor of it (to use Galbraith's characterization) -- is not so much about the objectives of monetary policy as about its implementation, particularly the way in which monetary decisions are made and explained. Neither the inflation-targeting regimes adopted by countries such as Australia, Canada, Israel, New Zealand, Spain, Sweden, and the United Kingdom nor the arguments advanced in our book commit inflation targeters to a destructive, single-minded focus on inflation in the short term. To the contrary, the features that accompany such systems -- namely, the added transparency and accountability of central banks that have publicly announced inflation targets -- are the best guarantees against policy mistakes. This is why the European Central Bank and the Federal Reserve Board should adopt these measures.

Galbraith is too concerned with demolishing a straw man to pay much attention to what our book actually says. He asserts, for example, that "the authors of Inflation Targeting do not discuss the Humphrey-Hawkins Act," the U.S. legislation most closely addressing the Fed's mandate and accountability. If Galbraith had glanced at our index, he would have seen that we actually have a three-page discussion of Humphrey-Hawkins in the context of our recommendations for enhancing the transparency of the Fed's operations. A little later, he dismisses our argument that inflation-targeting countries have enjoyed improved economic performance: "A fair evaluation of this claim would require a comparative perspective, which the authors do not provide." Yet our book contains 9 country studies spread over 163 pages, plus a chapter comparing the economic performance of 4 inflation-targeting countries to that of 4 nontargeting countries. What does this provide if not "a comparative perspective," and a fair one at that?

IT'S IN THERE

Galbraith contends that our argument "rests on a theory that links monetary policy exclusively to inflation control and denies central banks any important role in determining economic growth and unemployment." He further implies that if the Fed had followed our advice in its policymaking during the 1990s, it would have raised interest rates unnecessarily because it paid exclusive attention to the "natural rate of unemployment" while ignoring the leading economic indicators. Regarding the first claim, we state quite explicitly in Inflation Targeting that "the idea that monetary policy literally has no goals other than to control inflation would find little support from the public, from central bankers, or from monetary economists," and it finds none from us either, as our argument makes clear. With respect to the allegation that we favor a blinkered Fed, in our book we note that "inflation targeting requires the central bank to use structural and judgmental models of the economy, in conjunction with whatever information it deems relevant. In other words, inflation targeting is very much a 'look at everything' strategy."

On the fundamental issue of monetary policy goals, Galbraith ignores what we wrote in favor of attempted mind-reading, commenting, "One suspects instead that what they really want is to abandon full employment as a formal objective of American monetary policy." If we really wanted that, we would have written that -- but we don't want it so we didn't. In our discussion of Humphrey-Hawkins -- the one that Galbraith claims does not exist -- we explicitly describe the implications of the Fed's adopting our inflation-targeting proposal: "The Humphrey-Hawkins legislation now in effect appears to be sufficiently broad and non-specific to make new legislation unnecessary to implement the framework we have proposed here. Nevertheless, it would be desirable to modify the [law so that it] specifies that price stability is the overriding long-run objective of monetary policy, but also mandates attention to other important economic goals." And as we conclude approvingly from our research on various countries' experiences with inflation targeting, "the notion that monetary policy-makers under inflation targeting are indifferent to the performance of the real economy is simply incorrect. The capacity to deviate from the target if necessary allows the central bank a significant degree of flexibility in trying to stabilize the economy in the short run."

TARGET PRACTICE

The reality about inflation targeting matters for much more than fairness to our work. The biggest current issues in monetary policy are, in the short run, avoiding deflation in Japan and the new European Central Bank's eurozone, and in the long run, setting the direction for American monetary policy in preparation for Alan Greenspan's inevitable departure as chair of the Fed. Inflation targeting of the type that we advocate is both the most economically beneficial and the most democratically accountable response to both of these challenges.