[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

ceed in keeping the unemployment rate below its full-employment level, then its
appropriate goals are to contribute to economic stability by ensuring that full employment
is maintained and by keeping inflation low. In this way, monetary policy ensures
that the economy can experience sustainable economic growth.
To achieve the goals of full employment and low inflation, the Fed can pursue
two types of policies. First, it can engage in countercyclical policies—policies
designed to keep the economy at full employment by smoothing out fluctuations
in the economy. If a recession begins, the Fed can try to stimulate the economy to
move unemployment quickly back to its full-employment level. As we learned in
Chapter 31, however, the economy can be stabilized around full employment with
low inflation or with high inflation, since the full-employment output level does not
depend on the average rate of inflation. Second, in addition to its countercyclical policies,
the Fed must ensure that its actions are consistent with maintaining a low
average rate of inflation. Central banks might try to stabilize the economy at full
employment without keeping average inflation low. Alternatively, they might keep
inflation low on average without helping to stabilize the economy at full employment.
Most central banks, including the Fed, try to undertake policies that achieve
both goals.
INFLATION TARGETING AND POLICY
TRADE-OFFS
If the goal of monetary policy is to help stabilize the economy at full employment
while still ensuring that inflation remains low, how should this policy actually be
implemented? In recent years, central banks in many countries (including Canada,
New Zealand, Mexico, England, Israel, and Sweden) have adopted inflation targeting
as a framework for carrying out monetary policy. As might be expected of any
approach used by such a diverse group of countries, its exact application has varied
greatly. Inflation targeting generally involves the central bank publicly defining its
policy goals solely in terms of keeping the inflation rate within a narrow range around
a low average level. For example, New Zealand, which was the first to use inflation
targeting to guide monetary policy, set a target for inflation of 0 to 2 percent. Under
a law passed in 1989, the governor of the Reserve Bank of New Zealand (New Zealand’s
“Alan Greenspan”) could be fired if inflation went above 2 percent. 1
Many economists have called on the Federal Reserve to adopt a formal policy
of inflation targeting. Among the most prominent advocates has been Ben Bernanke,
chairman of President George W. Bush’s Council of Economic Advisors and formerly
a member of the Federal Reserve Board of Governors and professor of economics
at Princeton University. Among the most prominent opponents of inflation targeting
has been Alan Greenspan, chair of the Board of Governors. Supports of inflation
targeting argue that the Fed, under Alan Greenspan, has behaved like an inflation
targeter, so it might as well be honest and adopt a formal inflation target. Others
worry that establishing a formal target for inflation on which the Fed’s performance
1 The target range has since been changed to 1 to 3 percent.
SHOULD THE FEDERAL RESERVE TARGET INFLATION? ∂ 849