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Is Inflation Targeting Dead?

It is with regret that we announce the death of Inflation Targeting. The monetary regime, known affectionately as “IT” to its friends, evidently passed away in September 2008. That the demise of IT has not been officially announced until now testifies to the esteem in which it was widely held, its usefulness as a figurehead for central banks, and fears that there might be no good candidates to assume its position as preferred anchor for monetary policy.

Inflation Targeting was born in New Zealand in March 1990. Admired for its transparency and accountability, it achieved success there, and soon also in Canada, Australia, the UK, Sweden and Israel. It subsequently became popular as well in Latin America (Brazil, Chile, Mexico, Colombia, and Peru) and in other developing countries (South Africa, South Korea, Indonesia, Thailand and Turkey, among others).

One reason that IT gained such wide acceptance as the champion nominal anchor was the failure of its predecessor, exchange rate targeting, in the currency crises of the 1990s. Pegged exchange rates had succumbed to fatal speculative attacks in many of these countries. The authorities needed something new to anchor the public’s expectations of monetary policy. IT was in the right place at the right time.

Before the reign of exchange rate targeting, in turn, the fashion in the early 1980s had been money supply targeting, the brainchild of monetarist Milton Friedman. The money supply rule had succumbed to violent money demand shocks rather quickly. Friedman’s general argument for rules over discretion, in order to make a commitment to low inflation credible, however, is still very influential.