Lecturer: Kenneth Kuttner (bio)

Summary

Monetary authorities increasingly address their objectives and policies in terms of a monetary policy framework characterizing the institutional setting and goals of the central bank. An essential element of any such framework is a nominal anchor for prices, and their expectations—a function traditionally fulfilled by money targets or exchange rate pegs. Over the past 15 years, however, inflation targeting has emerged as a leading alternative to these conventional anchors. Its proponents argue that inflation targeting offers more flexibility than an exchange rate peg, and greater reliability than a money-based framework. Although inflation targeting has worked well so far in the 21 industrialized and emerging market economies in which it is currently practiced, doubts remain about the framework’s broader applicability. Policymakers from countries with less well developed financial markets, for example, may worry that an increased emphasis on inflation would create risks that the financial system would be unable to deal with. Similarly, the adoption of inflation targeting requires increasing exchange rate flexibility, and thus greater vulnerability to exchange rate fluctuations.

Drawing on the readings listed below, and participants’ own experiences, the groups will discuss the key elements of inflation targeting and exchange rate-based monetary policy frameworks, and the considerations that go into choosing one over the other. The discussions will provide a forum to highlight some of the practical issues encountered in implementing the policy frameworks, and especially any necessary “preconditions” that might need to be established prior to adoption.

All participants should read the Overview on monetary policy frameworks. Depending on his or her interests, participants should at a minimum read either the three articles under the Issues in inflation targeting heading, or the three articles under the Issues in exchange rate policy heading. (Reading all the articles is encouraged, of course.) Finally, each participant should come prepared to describe his or her own country’s monetary policy framework as a point of departure in the discussion group. The Sample case studies may serve as a useful starting point in thinking about the practical issues encountered in implementing inflation targeting and exchange rate pegs.

Questions for Discussion ››

Overview on monetary policy frameworks

Fry, Maxwell et al. (2000), “Key issues in the Choice of Monetary Policy Framework.”

In Lavan Mahadeva and Gabriel Sterne, eds., Monetary Policy Frameworks in a Global Context. London: Routledge, ch.1, pp. 3-17.

Issues in targeting inflation

Debelle, Guy, Paul Masson, Miguel Savastano, and Sunil Sharma (1998). “Inflation Targeting as a Framework for Monetary Policy,” IMF Economic Issues No. 15, October.

Debelle, Guy (2001), “The Case for Inflation Targeting in East Asian Countries,” in Future Directions for Monetary Policies in East Asia, Reserve Bank of Australia.

Carare, Alina, Andrea Schaechter, Mark R. Stone, and Mark D. Zelmer (2002), “Establishing Initial Conditions in Support of Inflation Targeting,” IMF Working Paper No. 02/102, June.

Issues in exchange rate policy

Mussa, Michael, Paul Masson, Alexander Swoboda, Esteban Jadresic, Paolo Mauro, and Andrew Berg (2000), “Exchange Rate Regimes in an Increasingly Integrated World Economy,” IMF Occasional Paper No. 193, ch. 3, pp. 23-33.

Williamson, John (2001), “The Case for a Basket, Band and Crawl (BBC) Regime for East Asia,” in Future Directions for Monetary Policies in East Asia, Reserve Bank of Australia; also read the published comments on the paper.

Duttagupta, Rupa, Gilda Fernandez, and Cem Karacadag (2004), “From Fixed to Float: Operational Aspects of Moving Towards Exchange Rate Flexibility,” IMF Working Paper No. 04/126, July, 2004.

Sample case studies

Prasad, Eswar, Thomas Rumbaugh, and Qing Wang (2005), “Putting the Cart Before the Horse? Capital Account Liberalization and Exchange Rate Flexibility in China,“ IMF Policy Discussion Paper 05/1, January.

Soikkeli, Jarkko, “The Inflation Targeting Framework in Norway,” IMF Working Paper No. 02/184, November.

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