Inflation Forecast Targeting: A Monetary Policy Strategy without Shortcomings?

This paper provides a critical discussion of the benefits and shortcomings of the concept of inflation forecast targeting (IFT) which is becoming the dominating monetary policy strategy in theory and practice. The paper contains an analysis of the more practical and institutional aspects arising when following an inflation forecast targeting regime as well as a discussion of the theoretical reasoning behind it. The setting of an inflation target itself is a useful instrument to increase accountability. That is because the public can make judgements on how successful monetary policy has been. The concept of IFT also ensures that monetary policy is forward-looking. Nevertheless, this paper will argue that the theoretical reasoning behind IFT has limitations. The assumed monetary transmission process is too one-sided and the role of money is not incorporated adequately. Inflation forecast targeting does not necessarily ease the business of communication by focusing on inflation forecasts as the main communication vehicle. On the contrary, there are substantial difficulties in explaining the implications of conditional or unconditional forecasts. Forecasts as complementing devices are surely useful and important in monetary policy making. The discussion of transparency and credibility within an IFT regime neglects the fact that in the long term credibility relies on the degree of price stability achieved and not the publication of minutes.