For release: June 15, 2004

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St. Louis Fed’s Review: Prospects and Problems of Inflation Targeting

ST. LOUIS, Mo.— Over the past two decades, a number of central banks have adopted explicit inflation targeting as a framework for conducting monetary policy. Perhaps no subject in recent memory has stirred as much debate, however, particularly in the United States, regarding whether central banks that do not employ IT should adopt the practice.

The July/August issue of Review, the Federal Reserve Bank of St. Louis' bimonthly publication of economic and business issues, features papers on inflation targeting that were presented at the Reserve Bank's 27th Annual Economic Policy Conference, held in October of 2003.

"There appeared to be widespread agreement among the conference participants that the essential elements of inflation targeting are (1) an explicit long-run inflation objective and (2) a commitment to transparency," said the conference co-chairs, Jeremy M. Piger and Daniel L. Thornton. Piger is an economist, and Thornton is a vice president and economic advisor for the St. Louis Fed.

The titles and authors of the papers are:

"Inflation Targeting and Optimal Monetary Policy," by Michael Woodford, the Harold H. Helm '20 professor of economics and banking at Princeton University. Woodfordnotes that the evidence to date suggests that inflation targeting, as practiced at central banks such as the Bank of England, can help safeguard a central bank against the trap of discretionary policymaking and helps the private sector to more accurately anticipate future monetary policy actions.

"The Macroeconomic Effects of Inflation Targeting," by Andrew T. Levin, senior economist in the division of monetary affairs and Fabio M. Natalucci, an economist in the division of international finance at the Board of Governors of the Federal Reserve System; and Jeremy M. Piger, an economist at the St. Louis Fed. Their analysis of the past decade of experience for industrial countries suggests that inflation targeting has played a role in anchoring inflation expectations and reducing the persistence of inflation.

"The Role of Policy Rules in Inflation Targeting," by Kenneth N. Kuttner, the Danforth-Lewis professor of economics at Oberlin College. Kuttner offers a detailed analysis of the primary issues in the debate over policy rules regarding inflation targeting —ad hoc vs. optimal policy rules, instrument rules vs. targeting rules, rules describing outcome vs. rules based on commitment, and mechanical rules vs. guidelines.

"Is Inflation Targeting Best-Practice Monetary Policy?" by Jon Faust, assistant director, and Dale W. Henderson, a senior advisor in the division of international finance at the Board of Governors of the Federal Reserve System. Faust and Henderson's research reflects the view that central banks should have clear, though possibly conflicting, goals and should strive to maximize public understanding of monetary policy.

"Practical Problems and Obstacles to Inflation Targeting," by Laurence H. Meyer, a distinguished scholar at the Center for Strategic and International Studies and president of Meyer's Monetary Policy Insights. Considering both the theoretical and political challenges of inflation targeting, Meyer concludes that the choice available to monetary policymakers is, ultimately, not between an explicit and implicit target, but between the current practice and a specific alternative.

Panel Discussion: Ben S. Bernanke, a member of the Board of Governors of the Federal Reserve System; Otmar Issing, a member of the executive board of the European Central Bank; and Donald L. Kohn, a member of the Board of Governors of the Federal Reserve System.

Authors offering commentaries are:

• Stephanie Schmitt-Grohé, a professor of economics at Duke University;
• Harald Uhlig, a professor of economic policy at the Institute for Economic Policy, School of Business Administration and Economics, Humboldt University;
• Monika Piazzesi, an assistant professor of finance at the University of Chicago;
• Benjamin M. Friedman, the William Joseph Maier professor of political economy at Harvard University; and
• Lars E.O. Svensson, professor of economics at Prince University.

Review is also available on the Bank’s web site.

With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve Banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, and provides payment services to financial institutions and the U.S. government.

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