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"Inflation and Monetary Policy"
Inflation and Monetary Policy
Author:
Jessica Linton
WORKING PAPER SERIES

Inflation Targeting: Why It Works

and How To Make It Work Better

William T. Gavin

Working Paper 2003-027B

http://research.stlouisfed.org/wp/2003/2003-027.pdf

September 2003

Revised September 2003

FEDERAL RESERVE BANK OF ST. LOUIS

Research Division

411 Locust Street

St. Louis, MO 63102

______________________________________________________________________________________

The views expressed are those of the individual authors and do not necessarily reflect official positions of

the Federal Reserve Bank of St. Louis, the Federal Reserve System, or the Board of Governors.

Federal Reserve Bank of St. Louis Working Papers are preliminary materials circulated to stimulate

discussion and critical comment. References in publications to Federal Reserve Bank of St. Louis Working

Papers (other than an acknowledgment that the writer has had access to unpublished material) should be

cleared with the author or authors.

Photo courtesy of The Gateway Arch, St. Louis, MO. www.gatewayarch.com

Inflation Targeting: Why It Works and How To Make It Work Better

William T. Gavin

Abstract

Inflation targeting has worked so well because it leads policymakers to debate, decide on,

and communicate the inflation objective. In practice, this process has led the public to believe

that the central bank has a long-term inflation objective. Inflation targeting has been successful,

then, because the central bank decides on an objective and announces it, not because of a change

in its day-to-day behavior in money markets or the way it reacts to news about unemployment or

real GDP. By deciding on an inflation rate and announcing it, the central bank is providing

information the public needs to concentrate expectations on a common trend. The central bank

gains control indirectly by creating information that makes it more likely that people will price

things in a way that is consistent with the central bank's goal.

The way to improve inflation targeting is to be more explicit about the average inflation

rate expected over all relevant horizons. Building a target path for the price level, growing at the

desired inflation rate, is the best way to institutionalize a low-inflation environment. In a wide

variety...

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