We examine to what extent variants of inflation-forecast targeting can avoid stabilization bias, incorporate history-dependence, and achieve determinacy of equilibrium, so as to reproduce a socially optimal equilibrium. We also evaluate these variants in terms of the transparency of the connection with the ultimate policy goals and the robustness to model perturbations. A suitably designed inflation-forecast targeting rule can achieve the social optimum and at the same time have a more transparent connection to policy goals and be more robust than competing instrument rules.

It is argued that inflation targeting is best understood as a commitment to a targeting rule rather than an instrument rule, eitherageneral targeting rule (explicit objectives for monetary policy) or a specific targeting rule (a criterion for (the forecasts of) the target variables to be fulfilled), essentially the equality of the marginal rates of transformation and substitution between the target variables. Targeting rules allow the use of judgment and extramodel information, are more robust and easier to verify than optimal instrument rules, and they can nevertheless bring the economy close to the socially optimal equilibrium.

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This paper reviews recent research on central bank independence (CBI). After we have distinguished between independence and conservativeness, the literature on optimal inflation contracts is discussed, followed by research in which the inflationary bias is endogenised. Finally, the various challenges that have been raised against previous empirical findings on CBI are reviewed. We conclude that the negative relationship between CBI and inflation is quite robust. JEL Classification: D72, E58 Helge Berger University of Munich and CESifo Center for Economic Studies Schackstr. 4 80539 Munich Germany e-mail: h.berger@ces.vwl.uni-muenchen.de Jakob de Haan University of Groningen Department of Economics The Netherlands Sylvester C. W. Eijffinger Tilburg University and CEPR CentER The Netherlands 2 1.

inflation, at least at any politically acceptable cost (Burns, 1979). A survey of six then-recent empirically estimated short-run Phillips curves by Okun (1978) sug-gested that the Federal Reserve would need to precipitate a 10 percent contraction of employment and output in the United States for one year for each permanent percentage point reduction of inflation that it wished to achieve. In other words, it appeared that it could take a modern Great Depression—a 10 percent contraction of output and employment sustained for almost 10 years—to achieve price stability. Even then, there was no guarantee that inflation would not begin to move higher again once restrictive monetary policy was relaxed. The arrival of Paul Volcker as chairman of the Federal Reserve in 1979 stands as a turning point. The Volcker Fed brought the inflation rate down to 4 percent by 1984, although it precipitated recessions in 1980 and 1981–82 to do so. Under Alan Greenspan, the Fed gradually worked the inflation rate down by the early 2000s below 2 percent, a range that Greenspan (2003) dubbed “effective price stability.” The improved inflationary picture in the United States was accompanied by parallel developments around the world. Average inflation worldwide declined from 14 percent in the early 1980s to 4 percent in the early 2000s (Rogoff, 2003).1 1 Rogoff (2003) reports that global inflation climbed in the first half of the 1990s and peaked at around 30 percent due to temporarily high inflation in the developing world, particularly, in transition economies.

Recent empirical research concerning the relationship between in ation and unemployment, a relationship that is central to the design of monetary policy, has been characterized by an active debate about the precision of relevant parameter estimates such as the estimated natural unemployment rate. This paper studies the optimal monetary policy in the presence of uncertainty about the natural rate and the short-run in ation-unemployment tradeo in a simple macroeconomic model. Two con icting motives drive the optimal policy. In the static version of the model, uncertainty provides a motive for the policymaker to move more cautiously than she would if she knew the true parameters. In the dynamic version, uncertainty also motivates an element of experimentation in policy. I nd that the optimal policy that balances the cautionary and activist motives typically exhibits gradualism, i.e. it is less aggressive than a policy that disregards parameter uncertainty. Exceptions occur when uncertainty isvery high and in ation close to target.

This paper examines what we have learned about monetary policy strategy and considers how we should change our thinking in this regard in the aftermath of the 2007-09 financial crisis. It starts with a discussion of where the science of monetary policy stood before the crisis and how central banks viewed monetary policy strategy. It then examines how the crisis has changed the thinking of both macro/monetary economists and central bankers. Finally, it looks at the extent to which the science of monetary policy needs to be altered and draws implications for monetary policy strategy.

The core requirements of inflation targeting are an explicit long-run inflation goal and a strong commitment to transparency. The framework built around these requirements has

We analyze the performance and robustness of some common simple rules for monetary policy in a new-Keynesian open economy model under different assumptions about the determination of the exchange rate. Adding the exchange rate to an optimized Taylor rule gives only slight improvements in terms of the volatility of important variables in the economy. Furthermore, although the rules including the exchange rate (and in particular,the real exchange rate) perform slightly better than the Taylor rule on average,they sometimes lead to very poor outcomes. Thus,the Taylor rule seems more robust to model uncertainty in the open economy.

Great progress was made in the theory of monetary policy in the last quarter century. Theory advanced on both the classical and the Keynesian sides. New classical economists emphasized the importance of intertemporal optimization and rational expectations. 1 Real business cycle (RBC) theorists explored the role of productivity shocks in models where monetary policy has relatively little effect on employment and output. 2 Keynesian economists emphasized the role of monopolistic competition, markups, and costly price adjustment in models where monetary policy is central to macroeconomic fluctuations. 3 The new neoclassical synthesis (NNS) incorporates elements from both the classical and the Keynesian perspectives into a single framework. 4 This “primer ” provides an introduction to the benchmark NNS macromodel and its recommendations for monetary policy. The author is Senior Vice President and Policy Advisor. This article originally appeared in International Finance (Summer 2002, 165–191) and is reprinted in its entirety with the kind permission of Blackwell Publishing