Academic journal article Federal Reserve Bank of St. Louis Review

Inflation Targeting: A View from the ECB

Academic journal article Federal Reserve Bank of St. Louis Review

Inflation Targeting: A View from the ECB

Article excerpt


What is the ultimate objective of monetary policy? What is the appropriate framework for conducting monetary policy? Central bankers and academics have been asking these critical questions for decades. This conference, in which I was honored to take part, was a milestone in this long-standing debate.

It is a fact that never before in the history of fiat money has there been so much consensus on the benefits of a low-inflation environment, and many central banks have achieved results consistent with this conviction. This is a tremendous achievement and one that could easily lead us to think that at last this long-standing debate has been settled once and for all.

However, I do sometimes wonder whether we are not too complacent in believing that the regime of low inflation will be with us "from here to eternity." There is always a risk that even great achievements, after a while, are taken as given and that their value is only rediscovered when they are in danger of becoming lost. In addition, recent history should tell us that the structure of the economy changes over time in a way that is difficult to anticipate and perceive in real time. This continuous mutation makes the task of monetary policy and its implementation even more challenging. It is the intrinsic nature of the economy that makes the debate on the aims of monetary policy and its appropriate framework so difficult to settle, and I believe that this debate will continue for some time to come.

In the course of the 1990s the inflation-targeting framework for the conduct of monetary policy has become popular among central banks and academics. In this paper I will highlight some of what I think are the distinguishing features and possible pitfalls of this approach. I will then draw comparisons with the European Central Bank's (ECB) monetary policy strategy, also in the light of the ECB's clarification of its strategy in May 2003.

Thus, in section 2, I would like to put the current debates on monetary policy into a historical perspective. In section 3, I will discuss what I see as the critical aspects of the inflation-targeting approach. Section 4 outlines the ECB's monetary policy approach and the ways in which it resembles and differs from the inflation-targeting framework.


Following the philosophy of "rules above authorities"--to paraphrase slightly the title of Henry Simons' famous article (1936)--one strand of research wanted the behavior of central bankers to be strictly constrained by a rule for conducting monetary policy. The most prominent advocate of this was Milton Friedman and his famous k-percent rule. The key argument in favor of the adoption of a simple strict rule was the acknowledgment of the economists' and central bankers' ignorance of the exact functioning of the economy and the long and variable time lags of monetary policy. It maintains that the actors of monetary policy know too little of the actual functioning of the economy to be able to perform activist policy and their discretionary actions would only exacerbate economic fluctuations instead of smoothing them. Strict rules prevent such problems, eliminating judgmental elements in monetary policy action and avoiding activist policy.

However, during the 1960s, few central bankers were in favor of rules, mostly because the performance of discretionary monetary policy at that time had been quite satisfactory, at least in the United States, and policymakers were increasingly confident of their ability to properly steer the performance of the economy. The 1970s marked the end of that overconfidence. In the period between the first oil shock and the early 1980s, the world's major economies experienced two recessions while inflation rose to double-digit levels. Although these events were not fully under the control of the monetary authorities, it is clear that the discretionary approach to monetary policy did make a negative contribution by not properly anchoring inflation expectations and instead allowing them to drift. …

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