Missing the Mark: The Truth About Inflation Targeting

In a general sense, a short-run inflation target sets a floor above zero, as well as a ceiling, for the rate of price increase for consumer goods. Adherence to the target means that the central bank must loosen monetary policy when the rate of price increase threatens to be too low, just as it must tighten policy when forecasted inflation is too high. Fighting deflationary tendencies becomes easier when inflation targets are publicly announced, for two reasons. First, the target may help to anchor the public's expectations of inflation, preventing an upward inflationary spiral when the central bank pursues expansionary policies to resist deflation. Second, the transparency and accountability of the policy process in inflation-targeting regimes implies that the central bank will be called to account should its policies prove excessively deflationary. The need to insure against deflation is why we strongly advocate greater-than-zero inflation targets in our book, and we state repeatedly that undershooting the inflation target must be opposed every bit as strenuously as overshooting it.

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The greater transparency of policymaking under inflation targeting is also why we recommend this approach for a post-Greenspan Fed. The Fed has performed well during the 1990s, using policies that in many ways -- particularly in their emphasis on keeping inflation low in the long run -- are similar to our proposals. The main difference between current Fed policy and a full-blown inflation-targeting approach is the Fed's relative lack of emphasis on transparency and accountability. The "just trust us" approach may work in a period when the chair and the Board of Governors command widespread support and confidence. But the happy state of affairs will not last forever. It is more sensible, and more democratic, to begin to act now to depersonalize monetary policymaking by increasing Fed transparency and accountability. For example, as was demonstrated by our case studies of the British and Canadian experiences, a formal inflation target would be constructive in channeling debates about monetary policy (in Congress and elsewhere) away from ideological generalities and toward specific issues, such as the appropriateness of the Fed's long-run inflation goal and the Fed's record in achieving its targets. An inflation target would also reduce uncertainty in financial markets about the Fed's prospective policies, since its targets and forecasts would be public information.

The importance of monetary policy arises from its effects on real economic growth. Price stability is not an independent objective but a means to an end. Central banks face the difficult practical problem of keeping inflation and expectations low in the long run (in order to promote growth), while permitting the short-run deviations from price stability that are necessary to keep the macroeconomy on course in the face of unpredictable economic and financial shocks. Our research convinces us that inflation targeting -- because it balances transparency and flexibility -- is the best available framework for managing that difficult task. Our book justifies that view through historical analysis and shows how inflation targeting has been, and should be, implemented in practice.

Ben S. Bernanke is Harrison and Beck Professor of Economics and Public Affairs and Chair of the Department of Economics at Princeton University. Thomas Laubach is an economist at the Federal Reserve Bank of Kansas City. Frederic S. Mishkin is A. Barton Hepburn Professor of Economics at Columbia University's Graduate School of Business. Adam S. Posen is Research Fellow at the Institute for International Economics.