Many inflation-targeting countries have an exact numeric target-for example, the United States has a target of 2% on average. Variations in inflation-targeting approachesĬentral banks vary in how they define and implement their inflation targets. This strategy is easily communicated through simple statements and has a performance measure that is easily observable and goal-oriented, features that Walsh (2015) argues help bolster central bank credibility and transparency. These statements of time horizons naturally create a quantifiable metric for evaluating central bank performance because they can be compared with how long it actually took.
Our strategy pairs tolerance bands-a range of allowable fluctuation around percentage point inflation targets-with projections for the future path of inflation.Ĭombining the two features can form an expected time horizon-in months, quarters, or years-for inflation to return to the band whenever it is outside. In this Economic Letter, we summarize our recent work in Davig and Foerster (2023) that develops a new framework for conducting monetary policy under inflation targeting with clear and quantifiable goals. Central banks are accountable to the public, so communicating a policy framework that lends itself to specific, quantifiable goals can help improve transparency and credibility (Walsh 2015). These characteristics are important not just for the economy but also for how to judge monetary policy success or failure. Exactly how central banks implement inflation targeting differs substantially across countries, including how they set their target and how they communicate the target to the public. Since New Zealand became the first country to adopt an explicit inflation target more than 30 years ago, inflation targeting has become the dominant model for conducting monetary policy around the world. Comparing previously projected horizons with realized horizons can be used to evaluate policy success. A new assessment method combines a percentage range around a target, known as an inflation tolerance band, with central banks stating how long it will take for high or low inflation to return to that range, known as a time horizon. However, central banks differ in how they conduct that policy and how they evaluate their success in meeting a stated inflation goal. Inflation targeting has become the dominant way countries approach setting monetary policy goals.
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