P248 inflation targeting(2)

Is inflation targeting dead? Central Banking After the CrisisCrisis managementThen comes the question of whether inflation targeting has had a negative impact onthe management of the Crisis. To start with, the empirical evidence is the inflationtargeting central banks outperformed the others (De Carvalho 2011). They acted faster,inflationary expectations remained better anchored around the target or pre-Crisislevels and did not face serious risk of deflation. This is not surprising once we recognisethat inflation targeting, as practised, is flexible in the sense of Svensson (2009). Thestrategy recognises the shorter-run need to stabilise the output gap, while keepinginflation close to target in the longer run. Indeed, Taylor rules – which imperfectlycapture the inflation-targeting strategy but can be seen as a rough approximation –suggested negative interest rates.The challenge starts once the zero lower bound is reached. At that stage, standardmonetary policy that relies on the interest-rate instrument becomes powerless. Thisis not a challenge to inflation targeting per se. The switch to nonstandard policieshas occurred in many countries, irrespective of the strategy. As previously noted,inflation-targeting central banks achieved a better record as far anchoring inflationaryexpectations is concerned. Nor is this episode arguing for a return to monetary targeting.Central-bank money expansion has not translated into increases in the wider aggregatesthat are the instruments used in monetary targeting. In effect, standard monetary policyis suspended due to extraordinary circumstances, which bears no implication for thestrategy used in normal times.ExitThe next challenge will occur when the time comes to exit nonstandard policies. Thismay turn out to be a complex task, but it is hard to see why inflation targeting could beat a disadvantage. Inflation targeting will issue timely signals that ‘exit time’ has come,one of the difficulties that lie ahead; and it should be of help in anchoring expectations.The Fed’s ‘forward guidance’ can be seen as a reminder that the expected output (or122