P248 inflation targeting(2)

Will central banking change?unemployment) gap is part and parcel of flexible inflation targeting. Indeed, it is ifanything less precise than the publication of expected future policy rates as is doneby some inflation-targeting central banks. The challenges are likely to concentrate onfinancial market conditions and on the choice of instruments to absorb liquidity, issuesthat are orthogonal to the monetary-policy strategy. Recent suggestions (e.g. Woodford2012) that nominal GDP-level targeting might usefully replace inflation targeting whilethe interest rate is at the zero lower bound aim at avoiding the currently valid concernthat undershooting inflation (or nominal GDP) in one year is carried out into the nextone. This is a feature of level targeting and could be applied to the price level. 1 Moreimportantly, it is presented as a temporary departure from inflation – or price-level –targeting. Temporary suspensions of any rule, however, carries the risk of underminingthe rule’s credibility. At this stage, when standard monetary policy is ineffective, thebenefit from switching strategy does not obviously outweigh the risk to the strategy’sintegrity.ConclusionFlexible inflation targeting has survived the test of a major financial crisis well. Thereis every reason to believe that the alternatives – monetary targeting, nominal-GDPtargeting, no explicit strategy at all – would not have done a better job. The buddingexit-strategy debate may point to interesting alternative temporary approaches butcredibility is at risk. This does not mean that monetary policy has reached a level ofperfection such that future changes are ruled out. In particular, central banks differin many details of the strategy, especially regarding the nature of the mandate andcommunication and transparency.The changes that have already occurred do not concern the strategy. They includethe recognition that central banks are and will always be lenders in last resort and1 Combining output and real GDP, however, introduces the very serious risk of imprecisely estimating current and futurepotential GDP.123