What have we learned from three decades of inflation targeting?
This comprehensive paper by Frederic S. Mishkin and Michael Kiley examines the remarkable evolution and success of inflation targeting as a monetary policy strategy from its inception in the early 1990s through the challenges of the 2020s. The authors identify five key elements that have made inflation targeting successful across different economies:
- Public announcement of medium-term numerical inflation targets (typically around 2 percent)
- Institutional commitment to price stability as the primary monetary policy goal
- Forward-looking, information-inclusive strategy that considers multiple economic variables
- Increased transparency through enhanced communication with markets and the public
- Enhanced accountability mechanisms for central banks to meet their inflation objectives
Global adoption and performance
Advanced economies
Inflation targeting spread rapidly among advanced economies, with most having adopted the framework either explicitly or implicitly before the Global Financial Crisis. The Federal Reserve and European Central Bank were notable late adopters, formally implementing inflation targeting in 2012 and 2003 respectively, as they had already incorporated many elements of the framework informally.
Emerging market economies
The research highlights particularly impressive adoption among emerging market economies, starting with Chile in 1990 and followed by Brazil, Mexico, Peru, and others. A significant development was India’s adoption of inflation targeting in 2016, making it the most populous and least developed country to implement the framework.
Key challenges and solutions
Pre-crisis challenges (1990s-2007)
The authors identify several challenges that inflation targeting successfully addressed:
- Signaling delays were solved through “inflation forecast targeting” and regular Inflation Reports
- Rigidity concerns were addressed through “flexible inflation targeting” that balanced inflation and output objectives
- Supply shock management was handled by focusing on core inflation measures rather than headline inflation
Post-crisis developments
The paper documents significant institutional innovations that strengthened the framework:
- Macroprudential policies emerged as complementary tools to address financial stability concerns
- Enhanced scenario analysis improved forward guidance communication
- Better integration of conventional and unconventional monetary policy tools
Lessons from country experiences
Chile’s early success
Chile’s experience demonstrated that gradual hardening of inflation targets could work effectively in emerging markets, starting with high inflation and progressively lowering targets as credibility was established.
Brazil’s rapid implementation
Brazil’s case proved that inflation targeting could be implemented quickly even without complete institutional reforms, though the authors emphasize that government support for fiscal discipline remained crucial for success.
Emerging market resilience
The research shows that emerging market economies with inflation targeting frameworks demonstrated unprecedented resilience during the global shocks of 2008-2009, 2011-2013, and 2020-2022, maintaining policy accommodation despite currency pressures.
Future challenges and recommendations
Institutional integrity
The paper emphasizes that maintaining central bank independence is crucial as central banks face pressure to expand their mandates beyond price stability to include climate change and inequality objectives. The authors warn that such expansions could compromise the primary price stability mandate.
Policy tool integration
The research identifies the need for better integration of quantitative easing and forward guidance within inflation targeting frameworks, with clearer communication about the purposes and sequencing of these tools.
Fiscal and financial interactions
The authors highlight emerging risks from fiscal dominance and financial instability that could constrain monetary policy effectiveness, emphasizing the importance of maintaining appropriate separation between monetary policy and other government objectives.
The Evolution of Inflation Targeting from the 1990s to the 2020s: Developments and Challenges
Authors: Frederic S. Mishkin, Michael Kiley
From: Columbia University, Federal Reserve Board
Optimal window length in average inflation targeting
In this paper, Frantisek Masek and Jan Zemlicka employ a New Keynesian macroeconomic model that incorporates household heterogeneity (distinguishing between “saver” and “hand-to-mouth” households) and bounded rationality through cognitive discounting, which captures agents’ myopic behavior. The researchers analyze Average Inflation Targeting (AIT) with varying window lengths, comparing it against standard Inflation Targeting (IT) and Price Level Targeting (PLT). The model accounts for the effective lower bound (ELB) on interest rates and includes extensions for quantitative easing, backward-looking expectations, and both demand and supply shocks.
Findings
Optimal window length: Under conventional rationality assumptions, the welfare-optimal averaging window for AIT is infinitely long making it equivalent to PLT. Even with increased cognitive discounting (higher myopia), the optimal window remains finite but long, with AIT maintaining superiority over IT unless the central bank reacts with unrealistically aggressive policy responses.
Critical role of policy speed: The study reveals that the speed at which the central bank aims to return inflation to target is crucial for policy effectiveness. When central banks are patient in returning to target, long averaging windows prove optimal. However, if they pursue rapid corrections, shorter windows or IT may perform better.
Robustness across extensions: The superiority of history-dependent rules (AIT/PLT) over IT remains robust across various model extensions, including the addition of quantitative easing at the ELB and backward-looking components in expectations formation. These extensions reduce but do not eliminate the welfare gains from makeup rules.
ELB and deflationary bias: AIT and PLT effectively help mitigate the downward inflation bias associated with the ELB constraint. The welfare difference between local and global solution methods diminishes as history dependence increases or as agents become more myopic, indicating that makeup rules provide valuable stabilization even under bounded rationality.
Policy implications
Under realistic behavioral assumptions and policy rules, long averaging windows in AIT or PLT typically deliver superior welfare outcomes compared to standard inflation targeting.
Average inflation targeting: how far to look into the past and the future?
Authors: Frantisek Masek, Jan Zemlicka
From: ECB
