Saturday, March 21, 2009

More on Inflation Targeting Failures

In two previous posts, I've written about how inflation targeting became irrelevant in the UK and how it failed to anchor inflationary expectations and asset prices in Brazil. Other examples of similar failures have been popping up all around the world. Here are two important ones.

Even though the US has never formally adopted a full-fledged new-Keynesian inflation targeting regime, its monetary policy was based on a closet version of IT that used the federal funds rate as instrument. There's little left from the preexisting Fed monetary policy framework, as explained in this The Economist article. Another The Economist article talks about how the new-Keynesian inflation targeting regime has become irrelevant in Switzerland too, where the Swiss National Bank has been forced to artificially depreciate its currency.

The reason why most of these countries have abandoned their different implementations of inflation targeting is simple: inflationary or deflationary expectations have become irrelevant as monetary anchors and stopped responding to the new-Keynesian monetary instrument of choice, the nominal interest rate. Inflation targeting was not only unable to avoid financial instability in all these economies, but, more importantly, revealed itself to be impotent exactly when effective monetary policy became essential (I'll return to this point in a future post).

1 comment:

ENNYMAN said...

So much information, so little time. Yes, Jay Leno did make a very shrewd observation... The whole AIG fiasco is just that... Does anyone really know what is going on inside the Beltway? That is, the implications of anything they are reacting to and acting upon...
Keep up the good work.
e.