8

The Death of Inflation Targeting

CAMBRIDGE – It is with regret that we announce the death of inflation targeting. The monetary-policy regime, known as IT to friends, evidently passed away in September 2008. The lack of an official announcement until now attests to the esteem in which it was held, its usefulness as an ornament of credibility for central banks, and fears that there might be no good candidates to succeed it as the preferred anchor for monetary policy.

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

One reason that IT gained such wide acceptance as the monetary-policy anchor of choice was the demise of its predecessor, exchange-rate targeting, in the currency crises of the 1990’s. Pegged exchange rates had come under fatal speculative attack in many of these countries, whose authorities thus needed something new to anchor the public’s expectations concerning monetary policy. Inflation targeting was in the right place at the right time.

In the early 1980’s, prior to the reign of exchange-rate targeting, the fashion was money-supply targeting, the brainchild of the monetarist Milton Friedman. But that rule succumbed rather quickly to violent money-demand shocks, though Friedman’s general argument – that a credible commitment to low inflation requires favoring rules over discretion – remains very influential.