Inflation Targeting in Practice

In recent years, an inflation targeting framework for monetary policy has been adopted by New Zealand, Canada, the United Kingdom, Finland, Sweden, Australia, and Spain (in chronological order). Because the experience of most of these countries with monetary targeting or a fixed exchange rate had proved unsatisfactory, this new framework for the conduct of monetary policy was required. In theory, an inflation target is relatively straightforward. The central bank forecasts the future path of inflation; the forecast is compared with the target inflation rate; the difference between the forecast and the target determines the required adjustment of the monetary policy instrument. However, the experience to date of the inflation targeting countries has identified a number of complex operational issues. This paper highlights five aspects of the inflation targeting framework: the assignment of the target, the interaction with other policy goals, the definition of the target, accountability, and the role of inflation forecasts. It compares and contrasts the approaches that the countries have adopted in addressing these issues. As a result, the prerequisites for an inflation target framework can be distilled from the experience of these countries. The economic performance to date of the new framework appears promising. Inflation has been brought down in all seven countries. However, a downward trend in inflation during this time was a feature of most industrial countries, and not solely of those that practiced inflation targeting. Nevertheless, the inflation targeting framework has proven beneficial in addressing problems caused by lack of credibility in those countries that have adopted it.