Seasoned Flexible-Inflation-Targeting (FIT) Central Banks

 
Central Bank Transparency Leaders

Based on Al-Mashat et al. (2018), Haworth, Kostanyan and Laxton (2020) and Fornero, Kostanyan and Laxton (2020)

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New Zealand

Year adopted inflation targeting: 1989

Operational objectives for monetary policy are set out in the Remit. The current Remit sets out a flexible inflation targeting regime, under which the MPC must set policy to:

  • keep future annual inflation between 1 and 3 percent over the medium term, with a focus on keeping future inflation near the 2 percent midpoint; and

  • support maximum sustainable employment, considering a broad range of labour market indicators and taking into account that maximum sustainable employment is largely determined by non-monetary factors.

Some important references:

 

FIT = Flexible Inflation Targeting

IFT = Inflation Forecast Targeting
IFT = FIT
DM = Dual Mandate (Price Stability and Full Employment)
AIT = Average-Inflation Targeting

In this section we provide a summary of the principles of IFT regimes and a short list of country examples. This list of central banks is not meant to be exhaustive and we will add new countries over time. The countries share 2 key characteristics. First, long-term inflation expectations are very well-anchored to the long-term inflation target. Second, these central banks have very high levels of monetary policy transparency as measured by the index developed by Al-Mashat and others (2018), which has been designed specifically for very transparent FIT central banks.

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Image by Joshua Hoehne

US Chart Pack

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Czech Republic

Year adopted inflation targeting: 1997

The Czech National Bank's (CNB) monetary policy objective is set forth in Article 98 of the Constitution of the Czech Republic and in Article 2 of Act No. 6/1993 Coll., on the Czech National Bank. In particular, the CNB is required to maintain price stability. Without prejudice to its primary objective, the CNB shall support the general economic policies of the Government leading to sustainable economic growth.

Some important references:

 
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Chile

Year adopted inflation targeting: 1999

One of the objectives that the Organic Law establishes in its article 3 for the Central Bank of Chile is to ensure the stability of the currency, that is, to keep inflation low and stable over time.

It must also promote the stability and efficiency of the financial system, ensuring the normal functioning of internal and external payments.

These objectives help or allow the creation of a predictable environment for decision-making, helping to smooth economic cycles and laying the foundations for sustained growth in the country.

To meet its objectives, the Bank has, among other powers, regulate the amount of money in circulation and credit in the economy, so that they are sufficient for people, companies and institutions to carry out their transactions.

Some important references:

 
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United States

Year adopted inflation targeting: 2012

The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates.

The maximum level of employment is a broad-based and inclusive goal that is not directly measurable and changes over time owing largely to nonmonetary factors that affect the structure and dynamics of the labor market. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the shortfalls of employment from its maximum level, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments.

Some important references:

 

Speeches

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U.S. economy far from employment, inflation goals

February 24, 2021

Fed Governor Lael Brainard said that the U.S. economy remains far from the Federal Reserve’s goals for employment and inflation and Fed's monetary policy is going to continue to provide support until further progress has been made in boosting inflation and improving the labor market for all workers. She talked about Fed's new framework. Under the new framework Fed will no longer raise interest rates when the unemployment rate is low in anticipation of higher inflation, allowing more time for the labor market to heal and look beyond nominal unemployment rate numbers. 

Fed officials will also plan to keep support in place until average inflation is above 2% and on track to moderately exceed 2% for “some time,” she said.

Read original article on Reuters.

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The Federal Reserve's New Framework: Context and Consequences

January 13, 2021

Fed's vice chair Richard H. Clarida gave a speech at the "The Road Ahead for Central Banks," a seminar sponsored by the Hoover Economic Policy Working Group, Hoover Institution, Stanford, California.

In his speech, vice chair talked about Fed's new monetary policy strategy adopted in August 2020: temporary price-level targeting (TPLT). He summarized five features of Fed's TPLT framework:

  1. Committee expects to delay liftoff from the ELB (effective lower bound) until PCE (personal consumption expenditures) inflation has risen to 2 percent and other complementary conditions, consistent with achieving this goal on a sustained basis, have also been met.

  2. With inflation having run persistently below 2 percent, the Committee will aim to achieve inflation moderately above 2 percent for some time in the service of keeping longer-term inflation expectations well anchored at the 2 percent longer-run goal.

  3. The Committee expects that appropriate monetary policy will remain accommodative for some time after the conditions to commence policy normalization have been met.

  4. Policy will aim over time to return inflation to its longer-run goal, which remains 2 percent, but not below, once the conditions to commence policy normalization have been met.

  5. Inflation that averages 2 percent over time represents an ex ante aspiration of the FOMC, but not a time-inconsistent ex post commitment.

Read the full article here.​

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The Economy and Monetary Policy: A Conversation with Fed Vice Chair Richard Clarida at the Hutchins Center on Fiscal & Monetary Policy at Brookings

November 16, 2020

The Hutchins Center on Fiscal & Monetary Policy at Brookings hosted Richard Clarida, vice chair of the Board of Governors of the Federal Reserve, to talk about the latest developments in the economy and in monetary policy. The conversation came two weeks after the Fed’s November policy meeting—and two weeks after Election Day.

Clarida joined the Fed in September 2018 and led the Fed’s recent review of its long-term objectives and monetary policy strategy. He previously served as assistant secretary for economic policy of the U.S. Treasury in the George W. Bush administration, as a managing director of PIMCO, and as a professor at Columbia University.

The video and the transcript of the event. 

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Fed governors have recently given a number of speeches emphasizing the implication of flexible average inflation targeting.

October 14, 2020

Richard Clarida's speech at the 2020 Annual Membership Meeting of the Institute of International Finance, Washington, D.C. on October 14, 2020: “U.S. Economic Outlook and Monetary Policy”.

"The September FOMC meeting was the first since the Committee approved in August our new Statement on Longer-Run Goals and Monetary Policy Strategy and adopted a new policy framework.The changes we made in our September FOMC statement bring our policy guidance in line with this new framework. In our new framework, we acknowledge that policy decisions going forward will be based on the FOMC's estimates of "shortfalls [emphasis added] of employment from its maximum level"—not "deviations." This language means that going forward, a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy absent any evidence from other indicators that inflation is at risk of moving above mandate-consistent levels. With regard to our price-stability mandate, while the new statement maintains our definition that the longer-run goal for inflation is 2 percent, it elevates the importance—and the challenge—of keeping inflation expectations well anchored at 2 percent in a world in which an effective-lower-bound constraint is, in downturns, binding on the federal funds rate. To this end, the new statement conveys the Committee's judgment that, in order to anchor expectations at the 2 percent level consistent with price stability, it "seeks to achieve inflation that averages 2 percent over time," and—in the same sentence—that therefore "following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time." 

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Fed governors have recently given a number of speeches emphasizing the implication of flexible average inflation targeting.

October 7, 2020

John Williams's speech at the Hoover Institution Monetary Policy Virtual Series: The Road Ahead for Central Banks (delivered via video conference) on 7 October 2020: “The Longer-Run Framework: A Look Ahead”.

"September's FOMC statement clearly linked our policy to the key elements of the new policy framework. In particular, it stated that the Committee expects it will be appropriate to maintain the federal funds rate at its current target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time."

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The Federal Reserve extends their dual-mandate framework to also include average inflation targeting

August 27, 2020

Other countries should consider this to avoid getting stuck in low inflation traps.

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Avoiding and escaping low inflation traps

September 20, 2020

President Lagarde gave a nice speech on September 20, 2020 where she spelled out some preliminary considerations on the ECB’s  policy strategy review. Interestingly, the COVID-19 shock and adoption of flexible average inflation targeting in the United States with a dual mandate and fiscal backstop may incentivize policymakers in the euro area to develop a better macro framework to help prevent them from falling into low inflation traps. The experiences of Japan suggest that it can become more difficult to escape from low inflation traps the longer policymakers allow inflation to remain below their long-term target.  Indeed, the recent strength of the euro relative to the US dollar may reflect the fact that asset prices like the exchange rate are playing their role as a shock absorber in the United States. Unfortunately, the recent appreciation of the euro may provide another example of how asset prices like the exchange rate can become an important shock amplifier at the effective lower bound when other policy tools (combination of unconventional monetary policy and fiscal) are perceived to be insufficient to anchor inflation expectations to the target and eliminate economic slack.

See some examples of course material on implementing flexible AIT regimes with dual mandates.

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Transparent Monetary Policy: A History of Inflation Targeting in New Zealand

December 2019

This paper describes the history of inflation targeting at the Reserve Bank of New Zealand and how transparency has shaped the Reserve Bank’s approach to monetary policy. The story begins with how an inflation-targeting regime was adopted in 1989 to tame the high inflation of the time. The implementation of a forecasting and policy analysis system in 1997 provided the foundation for higher levels of transparency and the move to flexible inflation targeting. In 2019, the adoption of a dual mandate with an employment objective, the formalisation of a Monetary Policy Committee, and the publication of the Bank’s Monetary Policy Handbook marked a new phase of transparency and public accountability. Here is the link for the paper.