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The Case for Forecast Targeting as a Monetary Policy Strategy

  • Michael Woodford

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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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.21.4.3
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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. Svensson, Lars & Woodford, Michael, 2000. "Indicator Variables for Optimal Policy," Seminar Papers 688, Stockholm University, Institute for International Economic Studies.
  2. Luca Benati, 2006. "UK monetary regimes and macroeconomic stylised facts," Bank of England working papers 290, Bank of England.
  3. 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.
  4. Michael Woodford, 2005. "Central Bank Communication and Policy Effectiveness," NBER Working Papers 11898, National Bureau of Economic Research, Inc.
  5. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  6. 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.
  7. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
  8. Jansson, Per & Vredin, Anders, 2003. "Forecast-Based Monetary Policy: The Case of Sweden," International Finance, Wiley Blackwell, vol. 6(3), pages 349-80, Winter.
  9. 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.
  10. 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.
  11. 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.
  12. 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.
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