A Case for Inflation Targets in the United States and Japan

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The central banks of the world’s two largest economies are both worried but hopeful about inflation. The Federal Reserve is afraid inflation will increase, but hopes it will decrease. The Bank of Japan is afraid it will decrease, but hopes it will increase. Ironically, the Bank of Japan says it would like to tighten monetary policy more, while the Fed says it would not.

Clearly, the world’s leading central banks are struggling with what is happening to prices in their respective countries, what they should say about it, and, more importantly, what they should do about it. Inflation targeting may be a desirable approach to addressing these questions.

Keeping inflation low and stable is the primary goal of the world’s central banks. Virtually all have been strongly influenced by the “Great Moderation” whereby low and stable inflation rates have been associated with higher rates of growth and better overall economic performance. The basic reason for this association is the fact that high and volatile inflation rates are disruptive and empirically linked to poorer economic performance.