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The Case for Forecast Targeting as a Monetary Policy Strategy

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  • Michael Woodford

Abstract

At central banks around the world, including the Bank of England, Sweden's Riksbank, Norway's Norges Bank, and the Reserve Bank of New Zealand, policy is conducted on the basis of "inflation-forecast targeting": the central bank constructs quantitative projections of the economy's expected future evolution based on the way in which it intends to control short-term interest rates, and public discussion of those projections plays a critical role in justifying the banks' conduct of monetary policy to the public. What accounts for the appeal of this approach? Should it be adopted more widely or more explicitly? I review the long-running debate between proponents of monetary rules and proponents of discretionary monetary policy and argue that inflation-forecast targeting represents a powerful synthesis of the two approaches. I explore some common questions that arise about inflation-forecast targeting and consider how the U.S. Federal Reserve might move toward an explicit policy of inflation-forecast targeting.

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Bibliographic Info

Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 21 (2007)
Issue (Month): 4 (Fall)
Pages: 3-24

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Handle: RePEc:aea:jecper:v:21:y:2007:i:4:p:3-24

Note: DOI: 10.1257/jep.21.4.3
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  1. Luca Benati, 2005. "U.K. Monetary Regimes and Macroeconomic Stylised Facts," Computing in Economics and Finance 2005 107, Society for Computational Economics.
  2. Gorodnichenko, Yuriy & Shapiro, Matthew D., 2007. "Monetary policy when potential output is uncertain: Understanding the growth gamble of the 1990s," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1132-1162, May.
  3. Arturo Estrella & Frederic S. Mishkin, 1996. "Is There a Role for Monetary Aggregates in the Conduct of Monetary Policy?," NBER Working Papers 5845, National Bureau of Economic Research, Inc.
  4. Lars E.O. Svensson, 1998. "Inflation Targeting as a Monetary Policy Rule," NBER Working Papers 6790, National Bureau of Economic Research, Inc.
  5. Lars E.O. Svensson & Michael Woodford, 2000. "Indicator Variables for Optimal Policy," NBER Working Papers 7953, National Bureau of Economic Research, Inc.
  6. Michael Woodford, 2005. "Central-bank communication and policy effectiveness," Discussion Papers 0506-07, Columbia University, Department of Economics.
  7. Jansson, Per & Vredin, Anders, 2003. "Forecast-Based Monetary Policy: The Case of Sweden," International Finance, Wiley Blackwell, vol. 6(3), pages 349-80, Winter.
  8. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  9. Kosuke Aoki & Kalin Nikolov, 2006. "Rule-Based Monetary Policy under Central Bank Learning," NBER Chapters, in: NBER International Seminar on Macroeconomics 2004, pages 145-195 National Bureau of Economic Research, Inc.
  10. Marc Giannoni & Michael Woodford, 2004. "Optimal Inflation-Targeting Rules," NBER Chapters, in: The Inflation-Targeting Debate, pages 93-172 National Bureau of Economic Research, Inc.
  11. Benjamin M. Friedman & Kenneth N. Kuttner, 1996. "A Price Target for U.S. Monetary Policy? Lessons from the Experience with Money Growth Targets," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 77-146.
  12. Leitemo, Kai, 2003. " Targeting Inflation by Constant-Interest-Rate Forecasts," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 609-26, August.
  13. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
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  1. Bernanke: Monetary Policy and the Housing Bubble
    by Mark Thoma in Economist's View on 2010-01-03 20:06:00
  2. Monetary Policy and the Housing Bubble
    by Guest Author in the big picture on 2010-01-04 11:00:02
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