## _wp03218

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### Introduction: purpose and approach
- Paper uses international experience with full-fledged inflation targeting (FFIT) to assess costs and benefits of greater monetary policy transparency for the United States, Japan and the euro area (the “G3”).
- Approach: thought experiment of a hypothetical switch from eclectic inflation targeting (EIT) to FFIT by the G3, drawing lessons from about 100 years of country experience with FFIT rather than attempting direct marginal-cost/benefit analysis for the G3.
- Key conclusions:
  - The costs and benefits of a move from EIT to FFIT depend on the initial level of credibility.
  - The U.S. and the euro area have a high degree of credibility; for them FFIT would incur a cost of a loss in policy discretion (at least in the short run) vs. the benefit of locking in low inflation credibility against future events.
  - Japan is in a deflationary liquidity trap; for Japan FFIT entails weighing a potential benefit of a more rapid end to deflation against the potential further hit to credibility from failing to end deflation in that context, plus risks from introducing new and unknown monetary instruments to end deflation.
- Two key issues raised by a hypothetical move to greater transparency by the G3:
  - How much scope for discretion, if any, would be lost by greater transparency?
  - How would the G3 be held accountable for numerical inflation targets in the absence of most elements of the FFIT framework?

### I. A brief overview of the FFIT regime
- Definitions and role:
  - A monetary policy regime “encompasses the constraints or limits imposed by custom, institutions and nature on the ability of the monetary authorities to influence the evolution of macroeconomic aggregates” (Bordo and Schwartz, 1995).
  - A nominal anchor is a nominal variable serving as a target for monetary policy and tying down inflation expectations and price stability.
  - FFIT: a commitment to a quantitative inflation target institutionalized via a transparent monetary framework that fosters accountability of the central bank to the target.
- Rationale: FFIT addresses two forward-looking commitment problems:
  - “Inflation bias” from the time consistency problem (Barro and Gordon, 1983; Kydland and Prescott, 1977).
  - “Output stabilization bias” caused by discretionary monetary policy and forward-looking private sector inflation expectations (Woodford, 1999).
- Common success ingredients for FFIT:
  - (i) a strong fiscal position and well-established macroeconomic stability;
  - (ii) a well-developed financial system;
  - (iii) central bank instrument independence and a mandate to achieve price stability;
  - (iv) reasonably well understood channels between policy instruments and inflation;
  - (v) a sound methodology for devising inflation forecasts.
- Historical notes:
  - New Zealand pioneered FFIT in 1989.
  - Today at least 20 countries operate under FFIT, including seven industrial countries and thirteen emerging market countries.
  - Paper focuses on industrial FFIT (IFFIT) countries when contrasting with G3.

### II. Differences between the EIT and IFFIT monetary policy frameworks
- Central distinction: mix of commitment versus discretion.
  - Measures from Fry and others (2000) rate indicators from 0 to 100 with 100 denoting the strongest commitment and most discretion.
  - In the commitment vs. discretion space:
    - IFFIT countries are toward the upper left: strong focus on inflation and little discretion.
    - EIT countries (the G3) are in the lower right: higher discretion and less focus on inflation.
- Transparency and accountability:
  - Under FFIT the inflation forecast is the effective intermediate target because of policy lags; transparency helps the public monitor adherence to the inflation objective and accountability ensures central banks are held responsible.
- Transparency practices—IFFIT countries:
  - IFFIT countries announce numerical inflation targets over a specified horizon.
  - All IFFIT central banks produce a detailed inflation forecast.
- Transparency practices—G3:
  - The ECB and the Bank of Japan have “almost-quantitative” inflation targets; the Federal Reserve does not state a numerical target.
  - None of the G3 publishes detailed inflation forecasts, although the ECB and BoJ have begun to provide more discussion of the inflation outlook.
- Empirical indicator caveat:
  - The Fry and others (2000) data were collected in 1999; Norway formally adopted FFIT in March 2002. These data are not available for the ECB.

### Transparency and accountability: G3 specifics and IFFIT communications (selected)
- ECB objective and practice:
  - Objective: “The primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, ESCB shall support the general economic policies in the Community...”
  - Maintain inflation rates close to 2 percent over the medium term.
  - Publication: Monthly Bulletin.
- Bank of Japan objective and practice:
  - Objective: “Currency and monetary control shall be aimed at, through the pursuit of price stability, contributing to the sound development of the national economy.”
  - The Bank of Japan says it will continue its monetary easing measures until the CPI registers stably a zero percent or an increase year on year.
  - Communications: Outlook and Risk Assessment of the Economy and Prices (Monthly); semi-annual appearance of Policy Board members before the Diet.
- United States objective and practice:
  - Objective: [conduct policy] “commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-run interest rates ”
  - No formal numerical target listed.
  - Communications: Semi-annual Monetary Policy Reports to Congress; semi-annual appearance of Chairman before congressional committee; Release of a statement on the day of a FOMC decision; publication of the minutes of the FOMC decision (with a 1-month delay).
- Formal accountability for adherence to an inflation target is a key element of all IFFIT monetary frameworks; achieved via transparent inflation targets and explicit government influence.
- G3 central banks have fewer institutional elements supporting formal accountability (no override provisions, no formal government oversight), though transparency has increased and two of the three have almost-quantitative inflation targets.

### Selected IFFIT country transparency specifics
- Australia:
  - Inflation target: On average 2-3 percent per annum over the medium term.
  - Communications: Monthly RBA Bulletin, quarterly statements on monetary policy, semi-annual appearance of governor before parliamentary committee.
- Canada:
  - Inflation target: 12-month CPI target range of 1-3 percent; monetary policy objective aimed to 2 percent target midpoint over the medium term.
  - Communications: Semi-annual monetary policy report with interim quarterly updates; semi-annual statements by the governor to parliamentary committees; regular speeches.
- Iceland:
  - Inflation target: 2.5 percent for 12-month CPI +/- 1.5 percent band.
  - Communications: Quarterly report on monetary developments and measures.
- Sweden:
  - Inflation target: 2 +/- 1 percent one to two years ahead.
  - Communications: Semi-annual report to the Parliamentary Committee on Finance plus governor’s appearance once a year (including target misses); quarterly inflation reports.
- New Zealand:
  - Inflation target: 1-3 percent on average over the medium term.
  - Communications: Monetary policy statement three times a year.
- Norway:
  - Inflation target: 2.5 percent over time (2 yr horizon).
  - Communications: Inflation report published three times a year; every session, ministry sends a communication to the Storting on activities of the Norges Bank.
- United Kingdom:
  - Objective: Price stability; subject to that, support economic policies of government including growth and employment.

### Key inflation statistics, CPI inflation, 1997–2002 (Median, Standard Deviation, Range)
- G3 economies:
  - Euro area — Median 2.01; Standard Deviation 0.69; Range 2.62
  - Japan — Median -0.40; Standard Deviation 1.08; Range 4.13
  - U.S. — Median 2.21; Standard Deviation 0.77; Range 2.69
- Industrial FFIT countries:
  - Australia — Median 2.16; Standard Deviation 1.94; Range 6.41
  - Canada — Median 1.90; Standard Deviation 0.91; Range 3.76
  - Iceland — Median 3.37; Standard Deviation 2.37; Range 8.61
  - New Zealand — Median 1.74; Standard Deviation 1.18; Range 4.47
  - Norway — Median 2.34; Standard Deviation 0.78; Range 3.92
  - Sweden — Median 1.01; Standard Deviation 1.10; Range 4.17
  - United Kingdom — Median 2.60; Standard Deviation 0.91; Range 3.51
  - Median (IFFIT countries) — 2.16; Standard Deviation 1.10; Range 4.17
- Observations:
  - U.S. and the euro area exhibit more stable inflation (lower standard deviation and narrower range) than any IFFIT country; median inflation for the U.S. and euro area is lower than the median for IFFIT countries.
  - Japan is distinguished by deflation, which reduces monetary policy credibility due to costs (sharp reductions in collateral value, frozen bank lending, increases in unemployment, ineffective monetary policy with zero nominal interest rates and a negative output gap).
- Note: The document repeats the phrase “2.5 percent RPI excluding mortgage interest rates over a two year horizon” as a heading/contextual figure.

### Structural differences and market indicators (selected medians and averages, 1990–99 unless noted)
- G3 (Median): GDP $billions 4,512; GDP per capita, $ 27,604; Broad money ratio to GDP 71.7; Stock market cap. ratio to GDP 87.6; Volume of stocks traded ratio to GDP 70.6; Volume of stocks traded $millions 4,580,134.
- G3 (Average): GDP $billions 5,360; GDP per capita, $ 27,486; Broad money ratio to GDP 78.3; Stock market cap. ratio to GDP 88.0; Volume of stocks traded ratio to GDP 112.0; Volume of stocks traded $millions 9,078,051.
- IFFIT (Median): GDP $billions 242; GDP per capita, $ 20,626; Broad money ratio to GDP 55.6; Stock market cap. ratio to GDP 66.2; Volume of stocks traded ratio to GDP 42.4; Volume of stocks traded $millions 165,461.
- IFFIT (Average): GDP $billions 365; GDP per capita, $ 22,861; Broad money ratio to GDP 60.5; Stock market cap. ratio to GDP 63.8; Volume of stocks traded ratio to GDP 57.5; Volume of stocks traded $millions 346,191.
- Implication: EIT (G3) countries have larger and more developed financial systems than FFIT countries; size and financial development may proxy for factors enabling low and stable inflation without formal accountability.

### Financial stability policies and tensions with FFIT
- Financial stability objective: forestall systemic financial crises or disruptions that adversely impact the real economy; disruptions transmit via mechanisms such as the financial accelerator and collateral effects.
- Three potential tensions between financial stability policies and FFIT:
  1. Lack of transparency of special instruments (lender-of-last-resort procedures, foreign exchange intervention) conflicts with FFIT’s emphasis on transparency; central banks often maintain “constructive ambiguity.”
  2. Differences in transmission lags between inflation-targeted policy and policies aimed at deflating asset price bubbles could create confusion about policy intent under FFIT.
  3. G3 role in maintaining international financial stability could introduce additional objectives into domestic monetary policy (example: U.S. loosening after the Russia crisis in late 1998).
- Resolution approach: increase transparency of financial stability policies so markets and the public can better understand the aims and expected effects; a credible policy regime reduces the risk that expansionary policies for financial stability are seen as threats to inflation targets.

### Country-specific issues and scenarios
- U.S. and euro area:
  - Have very strong price stability credibility; costs of adopting FFIT are mainly loss of policy discretion (short run) versus benefit of locking in credibility against future events.
  - Three illustrative adverse events that could undermine credibility and increase the benefits of FFIT:
    - A change in the head of the central bank potentially undermining credibility.
    - Fiscal dominance re-emerging (e.g., large projected federal deficits); FFIT with formal joint targets could reduce fiscal dominance risk.
    - Risk of future deflation; FFIT with an adequate “buffer zone” between zero and the inflation target could lower the deflation risk via the inflation expectations channel.
- Japan:
  - Faces a deflationary liquidity trap and does not meet preconditions for FFIT (well-established links between monetary instruments and inflation).
  - Liquidity trap linked to slow financial crisis and impaired monetary transmission due to ill-health of banks and intermediaries.
  - Potential benefits of FFIT: enhance inflation expectations channel, possibly bring a more rapid end to deflation.
  - Potential costs/risks: prolonged target misses could hurt credibility; untested monetary instruments to end deflation carry risks (e.g., direct provision of liquidity to nonfinancial private sector could slow financial reform).
  - Alternative: decisive integrated financial restructuring to restore bank intermediation and monetary transmission could be a safer path to end deflation than adopting FFIT with experimental instruments.

### Conclusions and research questions
- Summary conclusions:
  - U.S. and ECB: limited room for improving price stability credibility; FFIT would trade short-run discretion for locking in credibility against future adverse events.
  - Japan: adoption of FFIT involves weighing a potential faster end to deflation against risks to credibility and risks from new instruments in a liquidity trap.
  - G3 appear to be moving toward a regime resembling FFIT in transparency but not in formal accountability; formal accountability changes are unlikely for the ECB and U.S. given institutional constraints.
  - A hybrid regime between EIT and FFIT (transparency without full formal accountability) may emerge.
- Two key research questions:
  1. How much discretion would be lost by greater transparency? Suggests adding an FFIT-type policy reaction function to large models of the G3 to quantify differences in monetary aggregates and interest rates under FFIT-like rules.
  2. How would G3 countries be informally held accountable for numerical inflation targets? Proposal: rely on public and market pressures, with “Fed watchers” and market monitoring acting as informal accountability; high stock market trading activity in the G3 may facilitate market-based monitoring.

*Source: _wp03218 - Introduction............................................................................................................*

### Introduction............................................................................................................

### _wp03218 - Introduction............................................................................................................

### Introduction: purpose and approach
- Paper uses international experience with full-fledged inflation targeting (FFIT) to assess costs and benefits of greater monetary policy transparency for the United States, Japan and the euro area (the “G3”).
- Approach: thought experiment of a hypothetical switch from eclectic inflation targeting (EIT) to FFIT by the G3, drawing lessons from about 100 years of country experience with FFIT rather than attempting direct marginal-cost/benefit analysis for the G3.
- Key conclusion summary:
  - The costs and benefits of a move from EIT to FFIT depend on the initial level of credibility.
  - The U.S. and the euro area have a high degree of credibility; for them FFIT would incur a cost of a loss in policy discretion (at least in the short run) vs. the benefit of locking in low inflation credibility against future events.
  - Japan is in a deflationary liquidity trap; for Japan FFIT entails weighing a potential benefit of a more rapid end to deflation against the potential further hit to credibility from failing to end deflation in that context, plus risks from introducing new and unknown monetary instruments to end deflation.
- Two key issues raised by a hypothetical move to greater transparency by the G3:
  - How much scope for discretion, if any, would be lost by greater transparency?
  - How would the G3 be held accountable for numerical inflation targets in the absence of most elements of the FFIT framework?

### I. A brief overview of the FFIT regime
- Definition and role:
  - A monetary policy regime “encompasses the constraints or limits imposed by custom, institutions and nature on the ability of the monetary authorities to influence the evolution of macroeconomic aggregates” (Bordo and Schwartz, 1995).
  - A nominal anchor is a nominal variable serving as a target for monetary policy and tying down inflation expectations and price stability.
  - FFIT: a commitment to a quantitative inflation target institutionalized via a transparent monetary framework that fosters accountability of the central bank to the target.
- Rationale: FFIT addresses two forward-looking commitment problems:
  - “Inflation bias” from the time consistency problem (Barro and Gordon, 1983; Kydland and Prescott, 1977). Early solutions included the conservative central banker (Rogoff, 1985) and direct incentives for central banks (Walsh, 1995). Increased transparency and accountability have strengthened commitment to inflation targeting.
  - “Output stabilization bias” caused by discretionary monetary policy and forward-looking private sector inflation expectations (Woodford, 1999); a credible forward-looking inflation target smooths expectations and stabilizes output.
- Common success ingredients for FFIT (Bernanke and others, 1999; Carare and others, 2002):
  - (i) a strong fiscal position and well-established macroeconomic stability;
  - (ii) a well-developed financial system;
  - (iii) central bank instrument independence and a mandate to achieve price stability;
  - (iv) reasonably well understood channels between policy instruments and inflation;
  - (v) a sound methodology for devising inflation forecasts.
- Historical notes:
  - New Zealand pioneered FFIT in 1989.
  - Today at least 20 countries operate under FFIT.
  - These include seven industrial countries and thirteen emerging market countries.
  - This paper focuses comparison on industrial FFIT (IFFIT) countries when contrasting with G3.

### II. Differences between the EIT and IFFIT monetary policy frameworks
- Central distinction: mix of commitment versus discretion.
  - Measures from Fry and others (2000) rate indicators from 0 to 100 with 100 denoting the strongest commitment and most discretion.
  - In the commitment vs. discretion space:
    - IFFIT countries are toward the upper left: strong focus on inflation and little discretion.
    - EIT countries (the G3) are in the lower right: higher discretion and less focus on inflation.
- Transparency and accountability:
  - Under FFIT the inflation forecast is the effective intermediate target because of policy lags; transparency helps the public monitor adherence to the inflation objective and accountability ensures central banks are held responsible.
- Transparency practices—IFFIT countries:
  - IFFIT countries announce numerical inflation targets over a specified horizon.
  - All IFFIT central banks produce a detailed inflation forecast.
- Transparency practices—G3:
  - The ECB and the Bank of Japan have “almost-quantitative” inflation targets; the Federal Reserve does not state a numerical target.
  - None of the G3 publishes detailed inflation forecasts, although the ECB and BoJ have begun to provide more discussion of the inflation outlook.
- Empirical indicator caveat:
  - The Fry and others (2000) data were collected in 1999; there may be discrepancies with objectives today. Norway formally adopted FFIT in March 2002. These data are not available for the ECB.

### Selected IFFIT country transparency specifics (as presented)
- Australia: objective includes currency stability; maintenance of full employment, general welfare and prosperity. Inflation target: On average 2-3 percent per annum over the medium term; subject to that, to encourage the strong and sustainable growth in the economy. Communications: Monthly RBA Bulletin, quarterly statements on monetary policy, semi-annual appearance of governor before parliamentary committee.
- Canada: objective includes regulate credit and currency; control and protect external value of national monetary unit and mitigate fluctuations in level of production, trade, prices and employment. Inflation target: 12-month CPI target range of 1-3 percent; monetary policy objective aimed to 2 percent target midpoint over the medium term. Communications: Semi-annual monetary policy report with interim quarterly updates; semi-annual statements by the governor to parliamentary committees; regular speeches.
- Iceland: objective: Price stability. Inflation target: 2.5 percent for 12-month CPI +/- 1.5 percent band. Communications: Quarterly report on monetary developments and measures.
- Sweden: objective: Price stability; promote a safe and efficient payment system. Inflation target: 2 +/- 1 percent one to two years ahead. Communications: Semi-annual report to the Parliamentary Committee on Finance plus governor’s appearance once a year (including target misses); quarterly inflation reports.
- New Zealand: objective: Price stability. Inflation target: 1-3 percent on average over the medium term. Communications: Monetary policy statement three times a year.
- Norway: objective: Currency stability (national and international value). Inflation target: 2.5 percent over time (2 yr horizon). Communications: Inflation report published three times a year; every session, ministry sends a communication to the Storting on activities of the Norges Bank.
- United Kingdom: objective: Price stability; subject to that, support economic policies of government including growth and employment.

### Structure of the paper (organization)
- Section III: compares and contrasts institutional monetary policy framework of EIT and industrial FFIT countries.
- Section IV: assesses differences between EIT and industrial FFIT countries.
- Section V: discusses financial stability and EIT and FFIT.
- Section VI: addresses country-specific issues.
- Section VII: concludes.

*Source: _wp03218 - Introduction............................................................................................................*

### 2.5 percent RPI excluding mortgage interest rates over a two year horizon

### 2.5 percent RPI excluding mortgage interest rates over a two year horizon

### Transparency and Accountability of Monetary Frameworks
- ECB objective: “The primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, ESCB shall support the general economic policies in the Community...”  
  - Maintain inflation rates close to 2 percent over the medium term.  
  - Publication: Monthly Bulletin.
- Bank of Japan objective: “Currency and monetary control shall be aimed at, through the pursuit of price stability, contributing to the sound development of the national economy.”  
  - The Bank of Japan says it will continue its monetary easing measures until the CPI registers stably a zero percent or an increase year on year.  
  - Communications: Outlook and Risk Assessment of the Economy and Prices (Monthly); semi-annual appearance of Policy Board members before the Diet.
- United States objective: [conduct policy] “commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-run interest rates ”  
  - No formal numerical target listed.  
  - Communications: Semi-annual Monetary Policy Reports to Congress; semi-annual appearance of Chairman before congressional committee; Release of a statement on the day of a FOMC decision; publication of the minutes of the FOMC decision (with a 1-month delay).

- Formal accountability for adherence to an inflation target is a key element of all IFFIT monetary frameworks; achieved via transparent inflation targets and explicit government influence.  
- G3 central banks have fewer institutional elements supporting formal accountability (no override provisions, no formal government oversight), though transparency has increased and two of the three have almost-quantitative inflation targets.

### Differences between EIT and IFFIT countries
- EIT (explicit inflation targeting-lite) regimes provide greater discretion; EIT central banks are less explicit in commitment to inflation to retain flexibility for other objectives (e.g., output stability).  
- G3 revealed preference for EIT is attributed to high credibility with respect to price stability; credibility proxied by actual inflation performance (annual CPI changes, 1998–2003).

Key inflation statistics, CPI inflation, 1997–2002 (Median, Standard Deviation, Range)
- G3 economies:
  - Euro area — Median 2.01; Standard Deviation 0.69; Range 2.62
  - Japan — Median -0.40; Standard Deviation 1.08; Range 4.13
  - U.S. — Median 2.21; Standard Deviation 0.77; Range 2.69
- Industrial FFIT countries:
  - Australia — Median 2.16; Standard Deviation 1.94; Range 6.41
  - Canada — Median 1.90; Standard Deviation 0.91; Range 3.76
  - Iceland — Median 3.37; Standard Deviation 2.37; Range 8.61
  - New Zealand — Median 1.74; Standard Deviation 1.18; Range 4.47
  - Norway — Median 2.34; Standard Deviation 0.78; Range 3.92
  - Sweden — Median 1.01; Standard Deviation 1.10; Range 4.17
  - United Kingdom — Median 2.60; Standard Deviation 0.91; Range 3.51
  - Median (IFFIT countries) — 2.16; Standard Deviation 1.10; Range 4.17

- Observations:
  - U.S. and the euro area exhibit more stable inflation (lower standard deviation and narrower range) than any IFFIT country; median inflation for the U.S. and euro area is lower than the median for IFFIT countries.
  - Japan is distinguished by deflation, which reduces monetary policy credibility due to costs (sharp reductions in collateral value, frozen bank lending, increases in unemployment, ineffective monetary policy with zero nominal interest rates and a negative output gap).

- IFFIT countries used FFIT to disinflate or lock in low inflation at regime adoption. Three of seven IFFIT countries used FFIT to complete disinflation; four used FFIT to lock in recent gains.

### Financial Stability Policies and Tensions with FFIT
- Financial stability policy objective: forestall systemic financial crises or disruptions that adversely impact the real economy; disruptions transmit via mechanisms such as the financial accelerator and collateral effects.
- Three potential tensions between financial stability policies and FFIT:
  1. Lack of transparency of special instruments (lender-of-last-resort procedures, foreign exchange intervention) conflicts with FFIT’s emphasis on transparency; central banks often maintain “constructive ambiguity.”
  2. Differences in transmission lags between inflation-targeted policy and policies aimed at deflating asset price bubbles could create confusion about policy intent under FFIT.
  3. G3 role in maintaining international financial stability could introduce additional objectives into domestic monetary policy (example: U.S. loosening after the Russia crisis in late 1998).
- Resolution approach: increase transparency of financial stability policies so markets and the public can better understand the aims and expected effects; a credible policy regime reduces the risk that expansionary policies for financial stability are seen as threats to inflation targets.

### Structural Differences and Market Indicators
- Structural indicators, G3 and IFFIT countries (selected medians and averages, 1990–99 unless otherwise noted):
  - G3 (Median): GDP $billions 4,512; GDP per capita, $ 27,604; Broad money ratio to GDP 71.7; Stock market cap. ratio to GDP 87.6; Volume of stocks traded ratio to GDP 70.6; Volume of stocks traded $millions 4,580,134.
  - G3 (Average): GDP $billions 5,360; GDP per capita, $ 27,486; Broad money ratio to GDP 78.3; Stock market cap. ratio to GDP 88.0; Volume of stocks traded ratio to GDP 112.0; Volume of stocks traded $millions 9,078,051.
  - IFFIT (Median): GDP $billions 242; GDP per capita, $ 20,626; Broad money ratio to GDP 55.6; Stock market cap. ratio to GDP 66.2; Volume of stocks traded ratio to GDP 42.4; Volume of stocks traded $millions 165,461.
  - IFFIT (Average): GDP $billions 365; GDP per capita, $ 22,861; Broad money ratio to GDP 60.5; Stock market cap. ratio to GDP 63.8; Volume of stocks traded ratio to GDP 57.5; Volume of stocks traded $millions 346,191.
- Implication: EIT (G3) countries have larger and more developed financial systems than FFIT countries; size and financial development may proxy for factors enabling low and stable inflation without formal accountability.

### Country-specific Issues and Scenarios
- U.S. and euro area:
  - Have very strong price stability credibility; costs of adopting FFIT are mainly loss of policy discretion (short run) versus benefit of locking in credibility against future events.
  - Three illustrative adverse events that could undermine credibility and increase the benefits of FFIT:
    - A change in the head of the central bank potentially undermining credibility.
    - Fiscal dominance re-emerging (e.g., large projected federal deficits); FFIT with formal joint targets could reduce fiscal dominance risk.
    - Risk of future deflation; FFIT with an adequate “buffer zone” between zero and the inflation target could lower the deflation risk via the inflation expectations channel.
- Japan:
  - Faces a deflationary liquidity trap and does not meet preconditions for FFIT (well-established links between monetary instruments and inflation).
  - Liquidity trap linked to slow financial crisis and impaired monetary transmission due to ill-health of banks and intermediaries.
  - Potential benefits of FFIT: enhance inflation expectations channel, possibly bring a more rapid end to deflation.
  - Potential costs/risks: prolonged target misses could hurt credibility; untested monetary instruments to end deflation carry risks (e.g., direct provision of liquidity to nonfinancial private sector could slow financial reform).
  - Alternative: decisive integrated financial restructuring to restore bank intermediation and monetary transmission could be a safer path to end deflation than adopting FFIT with experimental instruments.

### Conclusions and Research Questions
- Summary conclusions:
  - U.S. and ECB: limited room for improving price stability credibility; FFIT would trade short-run discretion for locking in credibility against future adverse events.
  - Japan: adoption of FFIT involves weighing a potential faster end to deflation against risks to credibility and risks from new instruments in a liquidity trap.
  - G3 appear to be moving toward a regime resembling FFIT in transparency but not in formal accountability; formal accountability changes are unlikely for the ECB and U.S. given institutional constraints.
  - A hybrid regime between EIT and FFIT (transparency without full formal accountability) may emerge.
- Two key research questions:
  1. How much discretion would be lost by greater transparency? Suggests adding an FFIT-type policy reaction function to large models of the G3 to quantify differences in monetary aggregates and interest rates under FFIT-like rules.
  2. How would G3 countries be informally held accountable for numerical inflation targets? Proposal: rely on public and market pressures, with “Fed watchers” and market monitoring acting as informal accountability; high stock market trading activity in the G3 may facilitate market-based monitoring.

*Source: Tuladhar, 2003.*

### REFERENCES

### _wp03218 - REFERENCES

### Deflation, Liquidity Traps, and Japan's Experience
- Ahearne, Alan G., Joseph E. Gagnon, Jane Haltmaier, and Steven B. Kamin, 2003, “Preventing Deflation: Lessons from Japan’s Experience in the 1990s,” FRB International Finance Discussion Paper No. 729, June.
- Baig, Taimur, 2003, “Monetary Policy in a Deflationary Environment” in Japan’s Lost Decade: Policies for Economic Revival, ed. by Timothy Callen and Jonathan D. Ostry (Washington: International Monetary Fund).
- Bernanke, Ben S., 2003, “Some Thoughts on Monetary Policy in Japan,” paper presented at the Japan Society of Monetary Economics, Tokyo, May.
- ________, 2002, “Deflation: Making Sure ‘It’ Doesn’t Happen Here,” paper presented at the National Economists Club, Washington, D.C., November.
- Eggertsson, Gauti B., 2003, “How to Fight Deflation in a Liquidity Trap: Committing to Being Irresponsible,” IMF Working Paper 03/64 (Washington: International Monetary Fund).
- Kumar, Manmohan, Taimur Baig, Jörg Decressin, Chris Faulkner-MacDonagh, and Tarhan Feyzioglu, 2003, Deflation: Determinants, Risks, and Policy Response, Occasional Paper No. 221, International Monetary Fund.
- McCallum, Bennett, 2000, “Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates,” Journal of Money, Credit, and Banking, Vol. 32 (November), pp. 870–904.
- Okina, Kunio, and Shigenori Shiratsuka, 2003, “Policy Commitment and Expectation Formations: Japan’s Experience under Zero Interest Rates,” IMES Discussion Paper No. 2003-E-5, June.
- Svensson, Lars E.O., 2001, “The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap,” Monetary and Economic Studies, Vol. 19 (February), pp. 277–312.

### Inflation Targeting, Monetary Policy Rules, and Frameworks
- Bernanke, Ben S., Thomas Laubach, Frederic S. Mishkin, and Adam S. Posen, 1999, Inflation Targeting: Lessons from International Experience (Princeton: Princeton University Press).
- Carare, Alina, Andrea Schaechter, Mark R. Stone, and Mark Zelmer, 2002 “Establishing Initial Conditions in Support of Inflation Targeting,” IMF Working Paper 02/102 (Washington: International Monetary Fund).
- Carare, Alina, and Mark R. Stone, 2003, “Inflation Targeting Regimes,” IMF Working Paper 03/9 (Washington: International Monetary Fund).
- Debelle, Guy, 2003, “The Australian Approach to Inflation Targeting,” MIT, September, photocopy.
- Goodfriend, Marvin, 2003, “Inflation Targeting in the United States?,” paper presented at the NBER Conference on Inflation Targeting, Bal Harbour, Florida, January.
- Kydland, Finn E., and Edward C. Prescott, 1977, “Rules Rather than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy, 85: 473–92, June.
- Mishkin, Frederic S., 1999, “International Experiences with Different Monetary Policy Regimes,” Journal of Monetary Economics, Vol. 43 (June), pp. 579–605.
- Mishkin, Frederic S., and Klaus Schmidt-Hebbel, 2001, “One Decade of Inflation Targeting in the World: What do We Know and What do We Need to Know?” NBER Working Paper No. 8397 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Schaechter, Andrea, Mark R. Stone, and Mark Zelmer, 2000, Adopting Inflation Targeting: Practical Issues for Emerging Market Countries, IMF Occasional Paper No. 202 (Washington: International Monetary Fund).
- Stone, Mark, 2003, “Inflation Targeting Lite,” IMF Working Paper 03/12 (Washington: International Monetary Fund).
- Svensson, Lars E.O., 1999, “Inflation Targeting as a Monetary Policy Rule,” Journal of Monetary Economics, 43: 607–654.
- Svensson, Lars E.O., 2000, “Open-Economy Inflation Targeting,” Journal of International Economics, Vol. 50: 155–183.
- Svensson, Lars E.O., and Michael Woodford, 2003, “Optimal Policy through Inflation-Forecast Targeting,” NBER Working Paper No. 9747 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Truman, Edwin M., 2003, Inflation Targeting and the International Financial System: Challenges and Opportunities (Washington: Institute for International Economics).
- Tuladhar, Anita, 2003, “The Governance of Inflation Targeting Central Banks,” IMF Working Paper (Washington: International Monetary Fund), forthcoming.

### Transparency, Communication, and Central Bank Governance
- Chiu, Priscilla, 2003, “Transparency versus Constructive Ambiguity in Foreign Exchange Intervention”, Bank of International Settlements Working Paper No. 144 (Basel: BIS).
- Enoch, Charles, Peter Stella and May Khamis, 1997, “Transparency and Ambiguity in Central Bank Safety Net Operations”, IMF Working Paper 97/138 (Washington: International Monetary Fund).
- Jensen, Henrik, 2001, “Optimal Degrees of Transparency in Monetary Policymaking,” CEPR Discussion Paper No. 2689:1–25, February.
- Jaeger, Albert, 2003, “The ECB’s Money Pillar: An Assessment,” IMF Working Paper 03/82 (Washington: International Monetary Fund).
- Kieler, Mads, 2003, “The ECB’s Inflation Objective,” IMF Working Paper 03/91 (Washington: International Monetary Fund).
- Kohn, Donald, 2003, “Inflation Targeting in the United States? Comment,” paper presented at the NBER Conference on Inflation Targeting, Bal Harbour, Florida, January.
- Walsh, Carl, 1995, “Optimal Contracts for Central Bankers,” American Economic Review, Vol.1 (March), pp. 150–167.
- Rogoff, Kenneth, 1985, “The Optimal Degree of Commitment to an Intermediate Monetary Target,” Quarterly Journal of Economics, 100:1169–1189, November.

### Financial Stability, Asset Prices, and Transmission Mechanisms
- Bernanke, Ben, Mark Gertler, and Simon Gilchrist, 1998, “The Financial Accelerator in a Quantitative Business Cycle Framework,” NBER Working Paper No. 6455 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Bordo, Michael D., and Anna J. Schwartz, 1995, “Monetary Policy Regimes and Economic Performance: The Historical Record,” in Handbook of Macroeconomics Volume 1a, ed. by John Taylor and Michael Woodford.
- Borio, Claudio, and Philip Lowe, 2002, “Asset Prices, Financial and Monetary Stability: Exploring the Nexus,” BIS Working Paper No. 114 (Basel: Bank for International Settlements).
- Caballero, Ricardo J., and Arvind Krishnamurthy, 2001, “International and domestic collateral constraints in a model of emerging market crises,” Journal of Monetary Economics (Netherlands), 48, No. 3:513-48, December.
- Morsink, James, and Tamim Bayoumi, 1999, “A Peek Inside the Black Box: The Monetary Transmission Mechanism in Japan,” IMF Working Paper 99/137 (Washington: International Monetary Fund).

### Monetary Policy Theory and Implementation
- Auerbach, Alan J., and Maurice Obstfeld, 2003, “The case for open-market purchases in a liquidity trap,” NBER Working Paper No. 9814 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Barro, Robert J., and David B. Gordon, 1983, “Rules, Discretion and Reputation in a Model of Monetary Policy,” Journal of Monetary Economics, 12:101–121, July.
- Clarida, Richard, Jordi Gali, and Mark Gertler, 1998, “Monetary Policy Rules in Practice: Some International Evidence,” European Economic Review, Vol. 42: 1033–1067, June.
- Fry, Maxwell, DeAnne Julius, Lavan Mahadeva, Sandra Roger, and Gabriel Sterne, 2000, “Part I: Key issues in the choice of monetary policy framework,” in Monetary Policy Frameworks in a Global Context, ed. by Lavan Mahadeva and Gabriel Sterne (London and New York: Routledge).
- Rogoff, Kenneth, 1985, “The Optimal Degree of Commitment to an Intermediate Monetary Target,” Quarterly Journal of Economics, 100:1169–1189, November.
- Svensson, Lars E.O., 2002, “Monetary Policy and Real Stabilization,” paper presented at Rethinking Stabilization Policy, a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August.
- Woodford, Michael, 1999, “Commentary: How Should Monetary Policy Be Conducted in an Era of Price Stability?” Federal Reserve Bank of Kansas City Symposium on New Challenges for Monetary Policy, August.

*Reference list extracted from _wp03218 - REFERENCES (source PDF)._

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2003/_wp03218.pdf_