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Inflation Targeting as the New Golden Standard

  • Spivak, Avia
  • Sussman, Nathan

Financial globalization has seen the emergence of a new monetary standard based on inflation targeting. At the same time the most financially advanced economies moved away from exchange rate targeting which also characterized the previous era of globalization - the era of the Classical Gold Standard. Does the new financial environment of free capital flows constrain the independence of central banks to conduct monetary policy? We argue, and show empirically, that credible inflation targeting allows central banks to conduct an independent monetary policy as manifested in their ability to deviate from the world (Fed) interest rate. This new regime, with exchange rate flexibility, generates sufficient short term volatility that prevents short term arbitrage against central banks that deviate from the Fed rate. In contrast, during the Gold Standard only limited deviation was possible within the 'gold points'. On the other hand, the credibility of inflation targeting regime is as good as gold in anchoring inflation expectations for the long run as manifested in strong co-movement and similar levels of long term borrowing rates- just as was the case during the gold standard. We conclude that inflation targeting allows more flexibility than the Gold Standard to conduct monetary policy in the short run and has similar benefits for long term stability. We suggest that it is the new golden rule.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7001.

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Date of creation: Oct 2008
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Handle: RePEc:cpr:ceprdp:7001
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  1. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
  2. Svensson, Lars E O, 1992. "Why Exchange Rate Bands? Monetary Independence in Spite of Fixed Exchange Rates," CEPR Discussion Papers 742, C.E.P.R. Discussion Papers.
  3. Andrew K. Rose, 2006. "A Stable International Monetary System Emerges: Inflation Targeting is Bretton Woods, Reversed," NBER Working Papers 12711, National Bureau of Economic Research, Inc.
  4. Alex Cukierman, 1992. "Central Bank Strategy, Credibility, and Independence: Theory and Evidence," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262031981, June.
  5. Bordo, Michael D. & MacDonald, Ronald, 2005. "Interest rate interactions in the classical gold standard, 1880-1914: was there any monetary independence?," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 307-327, March.
  6. Michael B. Devereux & Philip R. Lane, 2000. "Exchange Rates and Monetary Policy in Emerging Market Economies," Working Papers 072000, Hong Kong Institute for Monetary Research.
  7. Richard Clarida & Jordi Gali & Mark Gertler, 1997. "Monetary Policy Rules in Practice: Some International Evidence," NBER Working Papers 6254, National Bureau of Economic Research, Inc.
  8. Alan M. Taylor, 2000. "Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price," NBER Working Papers 7577, National Bureau of Economic Research, Inc.
  9. Flandreau, Marc & Komlos, John, 2006. "Target zones in theory and history: Credibility, efficiency, and policy autonomy," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1979-1995, November.
  10. Barsky, Robert B & De Long, J Bradford, 1991. "Forecasting Pre-World War I Inflation: The Fisher Effect and the Gold Standard," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 815-36, August.
  11. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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