Jeremy Piger

English

Research Papers in Economics

April 2004
MonetaryTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
Does Inflation Targeting
Make a Difference?
O
ver the past 15 years, an increasing number of
central banks have adopted explicit inflation 
targeting as a framework for conducting monetary
policy. Inflation targeting takes many forms, but at its
heart is an announcement by the monetary authority of
its quantitative point target (or range) for inflation, regular
communication with the public on the progress being made
toward hitting the target, and mechanisms by which the
monetary authority is held accountable should it miss its
target. Inflation targeting was adopted by a handful of
mainly industrial countries in the early 1990s. Spurred by
its perceived success, a large number of countries, includ-
ing many emerging market economies, have recently
adopted inflation targeting. 
Despite the popularity of inflation targeting around the
world, and a general perception that it “works,” most early
research studies found little evidence that economic per-
formance in non-inflation-targeting countries had suffered
because they did not adopt inflation targeting. As more
data have become available, however, recent studies have
begun to unearth significant differences in the performance
of inflation-targeting vs. non-inflation-targeting economies.
One such study found that inflation targeting affects
the public’s expectations about inflation.1 In particular,
under an inflation-targeting regime, expectations about
inflation, particularly at longer horizons, should be
“anchored” by the target, and thus should be less affected
by changes in actual inflation. The table uses estimates
from this study to show how the public’s expectations of
future inflation (five and ten years out) would change in the
face of a 1-percentage-point increase in average realized
inflation over the preceding three years. For a group of
inflation-targeting countries, comprising Australia, Canada,
New Zealand, Sweden, and the United Kingdom, the
estimated response of inflation expectations to this increase
in realized inflation is quite small. However, for the non-
inflation-targeting economies, namely, the euro area, Japan
and the United States, the estimated responses are large
and statistically significant. 
Having inflation expectations that are well anchored—
that is, unresponsive to short-run changes in inflation—is
of significant benefit to a country’s economy. Because
expectations of higher future inflation will be negotiated
into various sorts of pricing contracts, such as labor con-
tracts, the public’s expectation of future inflation can be
self-fulfilling. Thus, keeping inflation expectations anchored
helps to keep inflation itself low and stable.
Of course, there are also potential drawbacks to the
adoption of inflation targeting that might offset any poten-
tial benefit in terms of anchored inflation expectations.
For example, some Federal Reserve policymakers have
argued that inflation targeting removes the flexibility needed
to respond to changing macroeconomic conditions, as well
as unusual events. Whether or not the United States would
experience a net benefit from adopting inflation targeting
is an active topic of debate, both inside and outside of
the Federal Reserve. The outcome of this debate will be
important in shaping the Federal Reserve’s policy frame-
work of the future. 
—Jeremy Piger
1 Levin, Andrew T.; Natalucci, Fabio M. and Piger, Jeremy M. “The Macro-
economic Effects of Inflation Targeting.” Federal Reserve Bank of St. Louis
Review, July/August 2004, 86(4) (forthcoming).
Available on the web at research.stlouisfed.org
Estimated Response of Inflation Expectations
to Change in Realized Inflation
Horizon of inflation 
expectations 
(years ahead)
51 0
Australia, Canada, 0.09% 0.01%
New Zealand, Sweden,
United Kingdom
Euro area, Japan, and 0.29% 0.24%
United States
Euro area and United States 0.34% 0.24%
SOURCE: See footnote 1.

Does inflation targeting make a difference?

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Does inflation targeting make a difference?

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