Inflation targeting has provided "a nominal anchor" and kept "inflation low and relatively stable" in turbulent times, Federal Reserve Bank of San Francisco President John C. Williams said Friday.
"[I]nflation targeting and related approaches to monetary policy have been remarkably successful at providing a nominal anchor and keeping inflation low and relatively stable during a period of severe turbulence," he told the South African Reserve Bank, according to prepared text released by the Fed. "Nonetheless, recent events have revealed some chinks in the armor of inflation targeting related to the zero lower bound on interest rates and financial instability."
He suggested, "The key is the anchoring of inflation expectations before the crisis and the actions taken to maintain price stability, and thereby hold the anchor in place, during and after the crisis."
Two challenges to inflation targeting, Williams pointed out, are zero lower bound nominal interest rates, and defining the proper role for monetary policy needed to maintain financial stability. "In countries where the ZLB has been a major constraint, achieving inflation goals has been especially challenging," he said.
" ZLB is likely to be a recurring issue for central banks that target low levels of inflation," Williams said.
Targeting inflation alone, as the recent global financial crisis may suggest, may not be sufficient to keep things on track and there are those that urge the use of monetary policy to minimize "risks to financial stability." Williams noted, "the near single-mindedness regarding the nominal anchor was originally seen as a virtue, not a vice."
The danger in allowing monetary policy a role comes into play when the goals of price stability and financial stability "are in conflict," Williams said, adding if price stability is ignored in favor of financial stability, it will create "serious long-run consequences for economic performance."
