Inflation Targeting and the Natural Rate of Unemployment
Inflation targeting has become an increasingly popular strategy for setting monetary policy during the last decade. While no countries had formal inflation targets before 1990, currently 22 countries use inflation targeting. One notable exception is the United States, where the Federal Reserve has a dual mandate to pursue both price stability and full employment. Some economists advocate inflation targeting for the United States, partly because they fear that otherwise the Fed will try to push unemployment below its "natural rate" - its lowest sustainable level - and trigger accelerating inflation. However, the natural rate theory has proven to be a poor guide for policy making over the last 10 years. Unemployment in 2000 fell 2 percentage points below estimates of the natural rate without spurring inflation. Since inflation targeting derives its justification largely from the theory of the natural rate, it is questionable whether the United States should switch to an inflation-targeting regime. These doubts are reinforced by the manifest success of monetary policy under the dual mandate.
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