5 - Inflation targeting twenty years on: where, when, why, with what effects and what lies ahead?

Summary

The ability to deal with demand shocks and financial crises can be enhanced by a commitment to an explicit [inflation] target.

Carl Walsh (2009a: 1)

Today, inflation targeting is being put to the test – and it will almost certainly fail.

Joseph Stiglitz (2008: 1)

Introduction

Two decades have passed since the Reserve Bank of New Zealand pioneered modern monetary policy practice by adopting inflation targeting. Since then, IT has gained followers and reputation, becoming the monetary regime of choice among many central bankers and academics. This preference has been revealed by the fact that no central bank endowed with monetary sovereignty that has adopted IT since 1989 has abandoned it – until now, at least. Although at the time of this writing, in the midst of the worst financial crisis and global recession in a lifetime, it seems a bit adventurous to provide a firm forecast on IT's future prospects, my bet is that Walsh will be proved right in his quote and Stiglitz wrong.

The widespread adoption of IT as the frontier monetary regime around the world poses some questions about the economic and institutional factors that lead countries to adopt and sustain IT, and about the potential policy and performance benefits of IT. On what drives countries to implement IT, earlier studies point towards the role of initial institutional and economic conditions satisfied when adopting and maintaining IT adoption (see, for example, Mishkin and Schmidt-Hebbel 2007a).