Thursday, March 20, 2008

It Works in Canada and Elsewhere, How About Inflation Targeting in the United States?

From the Bank of Canada's website:

Inflation-control targeting has been a cornerstone of monetary policy in Canada since its introduction in 1991. At present the target range is 1 to 3%, with the Bank's monetary policy aimed at keeping inflation at the 2% target midpoint.

The inflation-control target has helped to make the Bank's monetary policy actions more readily understandable to financial markets and the public. The target also provides a clear measure of the effectiveness of monetary policy. One of the most important benefits of a clear inflation target is its role in anchoring expectations of future inflation. This, in turn, leads to the kind of economic decision making — by individuals, businesses, and governments — that brings about non-inflationary growth in the economy.

Comment: As the top chart above shows, the Bank of Canada has been pretty successful at keeping inflation in the specified range from 1 to 3%, and pretty close to the point target of 2%. On the other hand, U.S. inflation has been much higher on average and more volatile over the same period, compared to Canada (see middle chart above). And during the 2003-2008 period, the Canadian dollar has strengthened versus the USD by 28.5%.

In all of the daily media discussions and hand-wringing about inflation, stagflation, and the falling dollar, what has happened to the discussion of "inflation targeting" as an alternative, rules-based approach to monetary policy? It seems like that topic has been ignored lately, even though inflation targeting has been successful in Canada, New Zealand, Sweden, Australia, Brazil, Chile, Israel, Korea, Mexico, South Africa, the Philippines, and Thailand, the Czech Republic, Hungary, and Poland.

As Fed Chairman Ben Bernanke said in 2003, "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."

Can we put inflation targeting back on the table for discussion? Given its proven record in countries like neighboring Canada, I think serious consideration should be given to adopting inflation targeting in the U.S.


At 3/21/2008 10:32 AM, Anonymous Anonymous said...

I believe that the present fed actions have prioritized maintaining liquidity to address the present credit crisis as more urgent than inflation targeting.
Is this not the case of choosing between a rock and a hard place? Inflation, at present, is less of a risk than bank runs that could be triggered by a major default.

It should also be noted that most of the appreciation of Canadian currency reflects the declining value of the U.S. greenback rather than Bank of Canada virtue.

At 3/21/2008 11:38 AM, Anonymous Anonymous said...

Anon 10:32 good points all around especially about revealing that the emperor has no clothes--i.e. the US$ has fallen not that the CAD$ has risen.

The US$ is the currency that has fallen while the CAD$ has maintained it's value within a few percent.

Now does a falling US$ serve us or hurt us in the U.S.?


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