A target rule: inflation targeting

A well-known approach, used in a number of industrialized countries (Canada, the United Kingdom, New Zealand. Sweden, Australia, Finland, Spain and Israel, to name a few) is known as inflation targeting. Rather than having some monetary quantity under the control of the authorities advance x percent per year, the idea of inflation targeting is to move right to the ultimate goal of monetary policy, stable prices - overall price levels should grow no more than y percent per year. Rather than having monetary authorities operate in terms of a simple role, the authorities are simply told to get inflation down, one way or another. In this sense, inflation targeting is a very different type of role. It gives very great discretion to the monetary authorities to pursue one objective, and no ability to pursue any other objective. While inflation targeting would seem to force central banks to become very specific about their policies, in fact the actual inflation targeting strategies have been more flexible. They have usually required the central bank to target between one and three percent inflation. They have also been defined in terms of some version of the, underlying rate of inflation - the overall inflation rate less food and energy prices, the impact of exchange rates, government taxes, and perhaps other clearly exogenous prices. Moreover, the real world inflation targets that have been instituted usually give the central bank an out, if this quarter it wants to worry about exchange rates, output gaps, or other economic goals.

Ben Bernanke and Frederic Mishkin. 1997 (with adaptations).