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

could be judged would reduce its flexibility to meet unforeseen future economic
developments.
The Pros Supporters of inflation targeting cite three chief advantages.
Inflation targeting focuses on what the Fed can achieve Currently, the Fed has multiple
goals. A 1977 congressional amendment to the Federal Reserve Act stipulated that
they include promoting “maximum” sustainable output and employment and “stable”
prices. The goal of stable prices is normally translated into a goal of low and stable
inflation. The Fed’s multiple aims concern both areas that it can control (such as
average inflation) and matters that it can affect in the short run but not in the long
run (such as output and employment). That it has multiple goals adds to the difficulty
of holding the Fed accountable for its policy decisions. By establishing a formal
target for inflation, the Fed would focus on an objective it can control and thereby
increase its accountability. Opponents argue that by focusing only on inflation, the
Fed would become less accountable for the effects of its policies on output and
employment.
It enhances credibility Price- and wage-setting decisions depend on how much inflation
individuals expect. If people begin to anticipate higher inflation, then actual
inflation will start to increase, forcing the central bank to raise interest rates to
lower aggregate demand and hold inflation in check. Inflation will remain low and
stable only if individuals believe that the central bank is committed to keeping inflation
low. Thus, the credibility of a central bank’s policy is crucial, and it may be
bolstered if a formal target for inflation is adopted. Opponents argue that credibility
is earned by implementing policies that maintain low inflation—central banks
cannot gain it by simply announcing an inflation target.
It institutionalizes good policy Many economists worry that U.S. monetary policy is
too dependent on the abilities of whoever happens to be the chair of the Board of
Governors. Policy under Alan Greenspan has been very successful, but other
chairmen in the past have been less talented. Proponents of inflation targeting
argue that its adoption would institutionalize good policy and help make policy
less reliant on any one individual. By promoting continuity in policy, it would also
serve to reduce the uncertainty that often accompanies a new chair’s arrival.
Formally targeting inflation would provide a framework for decisions that could
guide future policymakers, thereby reducing the risk of policy mistakes that lead
to inflation. Opponents also want to ensure the continuation of good policies, but
they worry that inflation targeting will not necessarily achieve that aim.
The Cons Those who argue against inflation targeting cite three chief disadvantages.
Inflation targeting promotes one goal over other equally important goals of monetary
policy The Federal Reserve is often described as now having a dual mandate: it
should be concerned both with keeping inflation low and with helping to stabilize
the economy at full employment. Achieving these two goals is viewed as consistent
with promoting economic growth. Adopting a formal inflation target would elevate
one goal at the expense of the other. While proponents argue that inflation
targeting is consistent with actively stabilizing output around full employment,
850 ∂ CHAPTER 38 CONTROVERSIES IN MACROECONOMIC POLICY