Bank for International Settlements

Már Gudmundsson

English

Research Papers in Economics

 
BIS Papers No 51  7
 
                                                
Challenges to inflation targeting: raising some issues
1 
Már Gudmundsson
2 
Prior to my appointment at the BIS in 2004 I was the Chief Economist of the Central Bank of 
Iceland. There I played a role in the 2001 adoption of the inflation targeting (IT) framework. 
At that time, I was a great fan of IT. However, experience has brought with it a better 
appreciation of the challenges that come with it. Iceland was the first country that I am aware 
of to suspend IT because of a financial crisis. Prior to that episode some countries had left 
IT, but they did so only to enter a monetary union. At the BIS, I took an attitude to IT that is 
similar to that of Winston Churchill’s about democracy: “No one pretends democracy is 
perfect or all-wise … indeed, it has been said that democracy is the worst form of 
Government except all those other forms that have been tried from time to time.”  
It is a fact that IT has been a great success story. New Zealand was the first country to adopt 
the framework, following the Bank of New Zealand Act of 1989. Since then, the IT group has 
grown to over twenty countries, among them several from Latin America. No country has to 
my knowledge regretted its adoption, although, as I noted, some left the group. The results 
have also been impressive in terms of the mean and the variability of inflation, without having 
a significant cost in terms of output volatility. Nonetheless, other countries have experienced 
similar developments, suggesting that, in some sense, this was driven by a benign 
environment, or good luck if you like. Despite such favourable conditions, it also seems to be 
the case that shocks to inflation have been less persistent among IT countries than among 
non-IT countries. But the goal of this session is not to discuss the success of IT. That story 
has been told over and over. Rather, we are here to discuss recent challenges that are 
putting IT to the test. Among those are the following:  
  First, how should IT central banks react to persistent and potentially long-lasting 
changes in relative prices of oil and other commodities, as experienced in the recent 
past?  
  Second, how does the ongoing process of financial globalisation complicate the 
conduct of monetary policy, especially in smaller countries? Related to this are the 
questions of how to deal with shrinkages in capital flows, the exchange rate, and the 
role, if any, of foreign exchange intervention in an IT framework. 
  Third, in light of the potential medium-term damage to macroeconomic and price 
stability that can come from boom-bust cycles in credit growth and asset prices, how 
should those cycles be dealt with in an IT regime? 
  Fourth, to what extent should financial stability concerns be factored into monetary 
policy decisions? Should there be more flexibility, longer horizons, leaning against 
the wind of asset price booms? Should there be a risk management approach in 
terms of financial disruptions – as generally spoken by Mishkin – or, should it be all 
of the above?  
I am not here to provide any answers. To discuss the issues, we called a very distinguished 
group of panelists.  
 
1   Presentation delivered at the LACEA Annual Meeting, Rio de Janeiro, November 2008. 
2   Governor, Central Bank of Iceland. At the time of the session, the author was Deputy Head of the Monetary 
and Economic Department at the BIS. 

Perspectives on inflation targeting, financial stability and the global crisis

http://www.bis.org/publ/bppdf/bispap51b.pdf

Perspectives on inflation targeting, financial stability and the global crisis

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