INFLATION TARGETERS IN PRACTICE: A LUCKY LOT?

FRANCISCO DE A. NADAL-DE SIMONE [*] Some observers have attributed the success of inflation targeters in reducing inflation to the global disinflation of the 1990s. As a result, inflation targeting countries have been considered to be a lucky lot. One key policy implication of that is that if the international environment becomes again hostile to low inflation in the future, inflation targeting will prove to have been a mere fad. This article views inflation targeting not just as a rule but as a framework for the conduct of monetary policy and it argues that currently available analyses of the experience of inflation targeting countries have serious weaknesses. One weakness is that those studies have not taken into account that regime changes may alter the quantitative and qualitative interaction among small, open economies and the rest of the world. Another weakness is that those studies have not recognized that the extraction of common trends and cycles is contingent on the nature of the monetary policy regime. It is likely that inflation ta rgeting frameworks may imply a new beneficial trend in monetary policy making. This suggests that if the international environment becomes again hostile to low inflation in the future, an inflation targeting framework may become a viable alternative to a central bank that remains committed to price stability. (JEL E52, F41, B41) I. MOTIVATION Starting with New Zealand in March 1990, a growing number of countries have introduced inflation targeting regimes. Those countries include industrial economies, such as Canada, the United Kingdom, and Australia, and emerging economies, such as Chile, Brazil, and Korea. A growing literature has looked at inflation targeting from different perspectives, such as the rationale for inflation targeting (e.g., McCallum, [1996]), implementation issues (e.g., Bernanke and Mishkin [1997]), and inflation targeting as an alternative to the use of monetary targets (e.g., Blinder [1999]). A strand of that literature has concentrated on the practice of inflation targeting and has looked at the actual performance of inflation targeters. The experience of early adopters of inflation targeting, such as New Zealand, Canada, and the United Kingdom, has been evaluated (e.g., Ammer and Freeman [1995], Haldane [1996], McCallum [1996], and Debelle [1997]). [1] The question posed has been whether inflation targeting has been instrumental in reducing inflation and, thus, what lessons for the conduct of monetary policy could be drawn from the relative performance of inflation targeters. Two opposite views have developed over time. While inflation rates in New Zealand, Canada, the United Kingdom, and Sweden were higher than the Office of Economic Cooperation and Development (OECD) average in the 1970s and 1980s, those countries' inflation rates fell below the OECD average after the implementation of inflation targets (McCallum, 1996). Undesirable effects on output growth were observed in most cases of disinflation, but they were short-lived (Mishkin and Posen, 1997). Thus, inflation targeting has been instrumental in reducing inflation. In the opposite camp, however, other observers view those results as misguided because disinflation in the 1990s has been a global phenomenon. Dueker and Fischer (1996), and Groeneveld et al. (1996) argue that the performance of inflation targeters has not been unambiguously successful when compared to the performance of their neighboring countries, that is, when New Zealand is compared with Australia, Canada is compared with the United States, or the United Kingdom is compared with Germany. Lee (1999) tackles the econometric problem that concurrent disinflation poses in the assessment of the relative performance of inflation targeters and also concludes that the relative behavior of macroeconomic variables in inflation targeting countries is not statistically different from what it would have been without the inflation targets. …