Inflation targeting: What have We learned?

Carl E. Walsh

University of California, Santa Cruz

July 22, 2008 1John Kuszczak Memorial Lecture, Bank of

Canada

Views on IT

• “All the major benefits that an inflation-targeting framework was supposed to deliver have been realized and, in some cases, exceeded.” (Bank of Canada 2006, p. 3)

• “Today, inflation targeting is being put to the test – and it will almost certainly fail.” (J. E. Stiglitz 2008)

July 22, 2008John Kuszczak Memorial Lecture, Bank of

Canada2

The spread of inflation targeting

• The number of inflation targeting central banks has grown steadily since 1990 (Dates: Batini and Baxton 2007 and Rose 2007) The spread number of inflation targeting central banks has grown steadily since 1990 (Dates: Batini and Baxton 2007 and Rose 2007)

0

5

10

15

20

25

30

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

emerging

industrial

July 22, 2008 3John Kuszczak Memorial Lecture, Bank of

Canada

The effects of IT

July 22, 2008John Kuszczak Memorial Lecture, Bank of

Canada4

| 1| 1|

T T

t t t t t t t t tx

1| 1|

T T

t t t t t t t tx v

|

T T

t t t t tv

Inflation: mean and std. dev.Circles – IT, Triangles – non-IT

0

2

4

6

8

10

12

14

0 2 4 6 8 10 12 14 16 18 20 22 24

Post-

IT / -

1990

Pre-IT / -1990

Mean Inflation Rates: Pre- IT & 1990 vs Post-IT & 1990

July 22, 2008 5John Kuszczak Memorial Lecture, Bank of

Canada

0

2

4

6

8

10

0 2 4 6 8 10 12 14 16 18 20 22 24 26

Po

st-

IT /

-1

99

0

Pre-IT / -1990

Standard Deviation of Inflation Rates: Pre- IT & 1990 vs Post-IT & 1990

0.00.2

0.40.6

[0.0-0.5[ [0.5-1.0[ [1.0-1.5[ [1.5-2.0[ [2.0-2.5[ [2.5-3.0[ [3.0-3.5] ]3.5-4.0[ ]4.0-4.5[ [4.5-5.0[ [5.0-5.5[ [5.5-6.0[

2005

Targe

t: 1.5 -

3.5

Inflati

on: 1.4

9

0.00.2

0.40.6

[0.0-0.5[ [0.5-1.0[ [1.0-1.5[ [1.5-2.0[ [2.0-2.5[ [2.5-3.0[ [3.0-3.5] ]3.5-4.0[ ]4.0-4.5[ [4.5-5.0[ [5.0-5.5[ [5.5-6.0[

2004

Targe

t: 1.5 -

3.5

Inflati

on: 3.4

8

00.2

0.40.6

[0.0-0.5[ [0.5-1.0[ [1.0-1.5[ [1.5-2.0[ [2.0-2.5[ [2.5-3.0[ [3.0-3.5] ]3.5-4.0[ ]4.0-4.5[ [4.5-5.0[ [5.0-5.5[ [5.5-6.0[

2003

Targe

t: 1.5 -

3.5

Inflati

on: 2.4

8

0.00.2

0.40.6

[0.0-0.5[ [0.5-1.0[ [1.0-1.5[ [1.5-2.0[ [2.0-2.5[ [2.5-3.0[ [3.0-3.5] ]3.5-4.0[ ]4.0-4.5[ [4.5-5.0[ [5.0-5.5[ [5.5-6.0[

2002

Targe

t: 1.5 -

3.5

Inflati

on: 1.5

2

00.2

0.40.6

[0.0-0.5[ [0.5-1.0[ [1.0-1.5[ [1.5-2.0[ [2.0-2.5[ [2.5-3.0[ [3.0-3.5] ]3.5-4.0[ ]4.0-4.5[ [4.5-5.0[ [5.0-5.5[ [5.5-6.0[

2001

Targe

t: 2.5 -

3.5

Inflati

on: -0

.13

00.2

0.40.6

[0.0-0.5[ [0.5-1.0[ [1.0-1.5[ [1.5-2.0[ [2.0-2.5[ [2.5-3.0[ [3.0-3.5[ [3.5-4.0] ]4.0-4.5[ [4.5-5.0[ [5.0-5.5[ [5.5-6.0]

2000

Targe

t: 3.5 -

4.0

Inflati

on: 3.7

0.00.2

0.40.6

[0.0-0.5[ [0.5-1.0[ [1.0-1.5[ [1.5-2.0[ [2.0-2.5[ [2.5-3.0[ [3.0-3.5] ]3.5-4.0[ ]4.0-4.5[ [4.5-5.0[ [5.0-5.5[ [5.5-6.0[

2006

Targe

t: 1.5 -

3.5

Inflati

on:1.1

4

0.00.2

0.40.6

[0.0-0.5[ [0.5-1.0[ [1.0-1.5[ [1.5-2.0[ [2.0-2.5[ [2.5-3.0[ [3.0-3.5] ]3.5-4.0[ ]4.0-4.5[ [4.5-5.0[ [5.0-5.5[ [5.5-6.0[

2007

Targe

t: 1.5 -

3.5

Inflati

on: 3.9

2

July 22, 2008 6John Kuszczak Memorial Lecture, Bank of

Canada

-2

0

2

4

6

8

10

12

14

0 2 4 6 8 10 12 14 16

Po

st-

IT /

-1

99

0

Pre-IT / -1990

Mean Industrial Production Growth: Pre- IT & 1990 vs Post-IT & 1990

Industrial production: growth rates and std. dev.Circles – IT, Triangles – non-IT

July 22, 2008 7John Kuszczak Memorial Lecture, Bank of

Canada

2

3

4

5

6

7

8

9

10

2 3 4 5 6 7 8 9 10

Post-

IT / -

1990

Pre-IT / -1990

Standard Deviation of Industrial Production Growth: Pre- IT & 1990 vs Post-IT & 1990

Inflation versus output volatilityCircles: IT, Triangles: non-IT

July 22, 2008 8John Kuszczak Memorial Lecture, Bank of

Canada

0

0.5

1

1.5

2

0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8

po

st-1

99

0 o

r p

ost

-IT

pre 1990 or pre-IT

Std. dev. of inflation relative to growth rate of industrial production

IT and real growth and volatility

July 22, 2008John Kuszczak Memorial Lecture, Bank of

Canada9

Table 5b: Treatment effect of CIT on the level and variability of output growth rates

Nearest Neighbor

3-Nearest

Neighbor

Radius Local Linear Regression

Kernel r=0.03 r=0.01 r=0.005

Effect on the output growth rates

ATT -0.638 -0.405 -0.214 -0.364 -0.340 -0.111 -0.096

Std. Err. (0.566) (0.477) (0.424) (0.484) (0.560) (0.429) (0.383)

P-value 0.253 0.366 0.599 0.459 0.525 0.796 0.808

Effect on the variability of output growth rates ATT 0.206 0.242 0.220 0.262 0.222 0.239 0.239

Std. Err. (0.231) (0.199) (0.176) (0.211) (0.252) (0.188) (0.168)

P-value 0.35 0.23 0.21 0.22 0.38 0.20 0.12

No. of treated 43 43 42 42 39 42 42

No. of control 35 66 190 145 97 195 195

No. of obs. 78 109 232 187 136 237 237

Transparency: 2005 versus 1998Dincer and Eichengreen (2007)

0

2

4

6

8

10

12

14

0 2 4 6 8 10 12 14

Tran

spar

ency

: 200

5

Transparency: 1998

Inflation targeters Non-inflation targeters

July 22, 2008 10John Kuszczak Memorial Lecture, Bank of

Canada

Current challenges

• “…inflation targeting does not solve many perennial judgment questions facing central banks, particularly with respect to supply disturbances that push inflation in one direction and economic activity in the other.” (Edwin Truman 2003)

• “It is not the task of monetary policy to attempt to influence changes in relative prices;….Global increases in commodity prices undermine the prosperity of Swedish households. Monetary policy cannot do anything about this.” (Riksbank Monetary Policy Report, 2008/2)

• “If central banks continue to focus on price stability and keep inflation low and stable, there is every expectation that the current degree of macroeconomic stability will continue.” (John Taylor 2005)

July 22, 2008John Kuszczak Memorial Lecture, Bank of

Canada11

Inflation experiences: OECD countries

02468

10121416

Inflation targeters

Non-inflation targeters (including Switzerland, excluding Turkey)

July 22, 2008 12John Kuszczak Memorial Lecture, Bank of

Canada

Inflation and expected inflation in Canada

July 22, 2008John Kuszczak Memorial Lecture, Bank of

Canada13

0

0.5

1

1.5

2

2.5

3

0

10

20

30

40

50

60

70

80

90

100

2006Q2 2006Q3 2006Q4 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1

Frac

tio

n o

f re

spo

nd

ing

firm

s

1% or less 2% or less 3% or less CPI inflation Exp. Inflation (bond yields)

Inflation and expected inflation in New Zealand

July 22, 2008John Kuszczak Memorial Lecture, Bank of

Canada14

0

0.5

1

1.5

2

2.5

3

3.5

4

CPI inflation 1-year ahead expected inflation 2-year ahead expected inflation

Expected inflation – U. S.

July 22, 2008John Kuszczak Memorial Lecture, Bank of

Canada15

0

0.5

1

1.5

2

2.5

3

3.5

4

U.S. 10-year inflation expectations(derived from adjusted TIPS)