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

they argue that if the Fed is held accountable for achieving its inflation target, it
will inevitably pay less attention to other goals.
Inflation targeting reduces flexibility Adopting a formal inflation target would reduce
the Fed’s flexibility in responding to new economic challenges. Supply shocks
may require that the Fed allow inflation to increase temporarily in order to limit
the economic contraction that would be needed to prevent its rise. A formal inflation
target might limit the ability of the Fed to make such trade-offs, since its performance
would be judged only on whether it maintained inflation at its target.
Proponents of inflation targeting argue that in practice, most central banks with
formal targets establish ranges for inflation—for example, the Riksbank, Sweden’s
central bank, has a target inflation rate of 2 percent, plus or minus 1 percentage
point—which enable the central bank to let inflation rise temporarily if necessary
to limit fluctuations in real output.
If it ain’t broke, don’t fix it Most commentators agree that the United States has
enjoyed the benefits of good monetary policy over the past twenty years. Given
this record of good performance, why change? Proponents of inflation targeting
argue that its adoption would help ensure that these good policies continue into
the future.
Case in Point
FED POLICY STATEMENTS—BALANCING
POLICY GOALS
In 1999, the U.S. economy continued to expand and unemployment remained at
historically low levels. The Fed was concerned that this strong growth would lead
to higher inflation. The chief uncertainty was whether the low unemployment
reflected a fall in the natural rate of unemployment. If it had fallen, then unemployment
could remain low without a risk of inflation increasing; if not, then a
continuation of actual unemployment below the natural rate would lead to a buildup
in inflationary pressures over time. In the latter case, the Fed would want to raise
interest rates to gradually slow the economy down.
During the summer, the Fed began to lean toward increasing interest rates. At
their meeting on May 18, 1999, the FOMC members decided not to change interest
rates, but they provided a clear signal that they were likely to raise rates soon. After
the meeting, the Fed released the following statement:
While the FOMC did not take action today to alter the stance of monetary policy, the
Committee was concerned about the potential for a buildup of inflationary imbalances
that could undermine the favorable performance of the economy and therefore
adopted a directive that is tilted toward the possibility of a firming in the stance
of monetary policy. Trend increases in costs and core prices have generally remained
quite subdued. But domestic financial markets have recovered and foreign economic
prospects have improved since the easing of monetary policy last fall. Against the
SHOULD THE FEDERAL RESERVE TARGET INFLATION? ∂ 851