Inflation Targeting In The World Economy

I N F L AT I O N TA RG E T I N G in the world economy I N F L AT I O N TA RG E T I N G in the world economy Ed w i n M . Tr u m a n INSTITUTE FOR INTERNATIONAL ECONOMICS Washington, DC October 2003 00--Front Matter--iv-xvi 9/10/04 6:54 AM Edwin M. Truman, senior fellow, was assistant secretary of the US Treasury for international affairs (1998–2000). He directed the Division of International Finance of the Board of Governors of the Federal Reserve System 1977 to 1998. From 1983 to 1998, he was one of three economists on the staff of the Federal Open Market Committee. He has been a member of numerous international groups working on international economic and financial issues, including the Financial Stability Forum’s Working Group on Highly Leveraged Institutions (1999–2000), the G22 Working Party on Transparency and Accountability (1998), the G10-sponsored Working Party on Financial Stability in Emerging Market Economies (1996–97), the G10 Working Group on the Resolution of Sovereign Liquidity Crises (1995–96), and the G7 Working Group on Exchange Market Intervention (1982–83). He has published on international monetary economics, international debt problems, economic development, and European economic integration. INSTITUTE FOR INTERNATIONAL ECONOMICS 1750 Massachusetts Avenue, NW Washington, DC 20036-1903 (202) 328-9000 FAX: (202) 659-3225 www.iie.com Page iv Copyright © 2003 by the Institute for International Economics. All rights reserved. No part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording, or by information storage or retrieval system, without permission from the Institute. For reprints/permission to photocopy please contact the APS customer service department at CCC Academic Permissions Service, 27 Congress Street, Salem, MA 01970. Printed in the United States of America 05 04 03 5 4 3 2 1 Library of Congress Cataloging-inPublication Data Truman, Edwin M. Inflation targeting in the world economy / Edwin M. Truman. p. cm. Includes bibliographical references and index. ISBN 0-88132-345-4 1. Inflation (Finance)—Government policy. 2. Monetary policy. 3. International finance. I. Title. HG229.T768 2003 339.5′3—dc22 2003061260 C. Fred Bergsten, Director Valerie Norville, Director of Publications and Web Development Brett Kitchen, Director of Marketing and Foreign Rights Typesetting by BMWW Printing by Kirby Lithographic Company, Inc. The views expressed in this publication are those of the author. This publication is part of the overall program of the Center, as endorsed by its Board of Directors, but does not necessarily reflect the views of individual members of the Board. 00--Front Matter--iv-xvi 9/10/04 6:54 AM Page v With love and appreciation to my mother, Elinor G. Truman, and to my father, David B. Truman, who died on August 28, 2003. For more than sixty years, they supported and encouraged me in every project, large or small, that I undertook, including this study. 00--Front Matter--iv-xvi 9/10/04 6:54 AM Page vi 00--Front Matter--iv-xvi 9/10/04 6:54 AM Page vii Contents Preface xiii Acknowledgments xv 1 1 5 8 11 13 What Is the Fuss All About? What Is Inflation Targeting? What Are the Issues? Plan of the Book Appendix 1.1 Monetary Policy Regimes 2 Intellectual Origins Choosing an Inflation-Targeting Framework Attraction of Inflation Targeting 17 17 38 3 Inflating Targeting in Practice Necessary Preconditions What the Skeptics Say The Framework in Practice: Four Principal Elements Actual and Poten