Recently, a number of countries have established inflation targets, usually quantitative in nature, and with a tolerance interval around the target, but with no intermediate targeting of the money supply or the exchange rate. In Discussion Paper No. 1511, Lars Svensson examines the potential problems monetary authorities face in implementing such targets, and the problems both the public and the market have in monitoring them.

Svenson finds that inflation targeting may be difficult to implement because monetary authorities have imperfect control over inflation. With the exception of major disturbances, such as the OPEC oil crises, current inflation is largely predetermined by previous decisions and contracts. Taken together, these factors make the evaluation of monetary policy by the public difficult. Svensson argues that these implementation and monitoring problems can be overcome by inflation-forecast targeting, in which the monetary authorities’ inflation forecast becomes an intermediate target. This is because the forecast is not only more suitable as a target – it is more controllable – but is more observable than inflation targeting itself. He also finds that very sophisticated money-growth targeting can sometimes achieve the same results as inflation targeting, but that this method is more difficult for the public to monitor. And if monetary-growth targeting is simplified to improve the monitoring problem, then the variability of inflation increases.

Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets
Lars E O Svensson