is so overwhelming that those who argue that monetary policy can improve real growth in the long term, or maintain a competitive real exchange rate in the long term, in developing countries need to have some pretty cogent arguments to support their claims. i have not myself seen those arguments. thirdly, it is sometimes suggested that inflation targeting is unsuitable for developing countries because it requires a sophisticated inflation forecasting ability in the central bank, or a sophisticated financial system, or a sophisticated measure of inflation. certainly, a good ability to forecast inflation, a sophisticated financial system, and a robust measure of inflation are all desirable things to have. but when new zealand began inflation targeting in the 1980s, we had none of those things. far - reaching economic restructuring meant that our econometric models were of little use. the financial system had just been freed from an extensive network of direct controls and was anything but sophisticated. our best - known measure of inflation included interest rates and house prices, and indeed it still does. poor tools make any monetary policy approach problematic, but it is not obvious that inflation targeting is more difficult than the available alternatives. and in any event, what are the alternatives? at a conference hosted by the swedish central bank in stockholm last year, papers explored three main approaches which the european central bank might take to monetary policy – money aggregate targeting, exchange rate targeting, and inflation targeting. most people at the conference felt that the relationship between the growth in money aggregates and inflation was so unstable, at least over policy - relevant periods, that for central banks to focus exclusively on such aggregates was likely to produce a very unstable inflation rate. it was also argued that virtually no central banks today ( the swiss national bank being a possible exception ) do focus exclusively on money aggregates, for precisely this reason. most of those at the conference also accepted that using monetary policy to maintain a nominal exchange rate peg, or even a nominal exchange rate ‘ zone ’, was fraught with danger. yes, exchange rate targeting has its advantages, perhaps the most important being the ability of a country with limited monetary policy credibility to borrow the credibility of the central bank of the country whose currency is ‘ targeted ’. in certain circumstances, and with strong institutional and political commitment, that may be an optimal policy. but as the countries of east asia have recently discovered, and the united kingdom and sweden discovered earlier in the decade, the risks are substantial. pegged exchange rates seem to attract speculation like bees to honey – with often

inflation rates ( often associated with the names of economists such as paul krugman, and akerlof, dickens, and perry ). but price stability in some sense seemed the appropriate goal, and the 1989 act makes the bank responsible for using monetary policy for the single objective of ‘ achieving and maintaining stability in the general level of prices ’. • thirdly, in a democratic society, it is appropriate that the elected government have an explicit role in defining what ‘ price stability ’ means, and the speed at which it should be achieved. this seemed to follow from the fact that, while there is no long - term trade - off between inflation and growth, there is clearly a trade - off in the short - term. hence, the 1989 act required there to be a written agreement, a policy targets agreement, between the minister of finance and the governor of the bank, signed on the appointment or re - appointment of the governor, giving specific content to ‘ stability in the general level of prices ’. this gave government an explicit role in defining the objective of monetary policy, subject to the need to have that objective consistent with some reasonable interpretation of the statutory objective of ‘ stability in the general level of prices ’. moreover, the act provided that the policy targets agreement could be changed during the course of a governor ’ s term of office by mutual agreement of the minister and the governor. indeed, where minister and governor can not agree, the act provides for an ‘ over - ride ’ whereby, if the government feels circumstances warrant the complete abandonment of the price stability objective, the policy targets agreement can be set aside, by the unilateral decision of the government, for a period of 12 months. the first policy targets agreement defined our target as inflation of between 0 and 2 per cent annually, as measured by the cpi, achieved before the end of 1992. 1 • the fourth principle on which the 1989 act was built was based on the observed fact that, internationally, central banks which are independent of political control seem to do a very much better job of keeping inflation low than do central banks which are subject to political direction. so the act provides that, once the policy targets agreement between minister and governor has been signed, the governor should be entirely independent in the formulation and implementation of monetary policy. the governor has absolutely no obligation to consult with the minister, with the treasury, or indeed with the board of the bank. note that the combination of these two principles - of political involvement in the