Lars Jonung DG ECFIN, EUROPEAN COMMISSION, Brussels

1. Comments on:Daniel L. Thornton The Evolution to Inflation Targeting: How Did We Get Here and Where Do We Need to Go? Lars Jonung DG ECFIN, EUROPEAN COMMISSION, Brussels 6th Norges Bank Monetary Policy Conference, June 11-12, 2009 The views expressed are my own and should not be attributed to the European Commission

2. The structure of the paper:1. The evolution of US monetary policy in the past 50 years (since the author took his first course in economics 45 years ago). (13.5 pages)2.The “dramatic shift to inflation targeting (IT)” in spite of “widespread scepticism” in the US economics profession to the ability of central banks to control inflation. (4 pages)3. The success of IT (1 page)4. The dangers to IT (14 pages)5. Implications for inflation-targeting central banks (0.5 page)

3. My comment is based on two issues: The first issue: Why do economic policies change course?I focus on the causes of the process where the old paradigm for stabilization policy (the monetary regime) is replaced by a new paradigm – a new regime

4. By answering the question why economic policies change course, I will provide an answer to A) Why was inflation targeting introduced? (Thorntons’s Section 2: the dramatic shift to IT)B) Why will inflation targeting be abandoned in the future? (Or: Where are the threats to inflation targeting?) (Thorntons’s Section 4: the dangers to IT)In this way I will complement the discussion by Thornton

5. The second issue: The international dimension (the history of IT):The paper by Thornton deals with the US record as if the FED has been an inflation targeting central bank. But the US has not officially adopted inflation targeting. It may be a closet inflation targeting central bank but it is not a true IT central bank with an explicit target for the rate of inflation (or the price level).Inflation targeting is not a US invention. US is not a leader but a follower.

6. Gunnar Myrdal in Monetary Equilibrium, 1939, p 8: Myrdal complained about the “English school of theorists” (Marshall, Pigou, Hawtry and Keynes):“suffers somewhat from the attractive Anglo-Saxon kind of unnecessary originality, which has its roots in certain systematic gaps in the knowledge of the German language on the part of the majority of English economists." If Myrdal had read Thornton’s paper today?

7. The international dimension:It all started with Knut Wicksell in April 14, 1898 in Nationalekonomiska Föreningen where he presented his ideas from Geldzins und Güterpreise (Interest and Prices).He suggested a simple rule:

8. Wicksell’s rule for monetary policy:“when the price level is rising, the rate of discount should be raised until the movement of prices is halted; when prices are falling, the rate of discount should be lowered until price stability is achieved.”This is the origin of IT.

9. Wicksell’s forecast in 1898 for the adoption of IT:‘Once a clear insight into the causes of the changes in the value of money and of the present instability thereof has been gained, the men concerned with the practical aspect will surely show themselves equal to the task of availing themselves of this insight to create a completely stable money value to the advantage of world commerce. Once the causes of the evil have been found, the therapy and, above all, the prevention of the disease will prove a comparatively simple matter.’ Wicksell had a strong belief in the rationality of central bankers

10. Irving Fisher’s forecast in 1935 (Stabilized Money) for the adoption of IT:“when knowledge of the Swedish experiment becomes generally available, the Swedish principles for monetary policy are sure to become accepted everywhere”

11. Erik Lindahl’s forecast in 1934 (Sweden’s monetary program) for the adoption of IT:IT belongs to the future but it will probably take a century for the world to adopt IT“a new era in monetary history has begun in Sweden. In time, so much knowledge of free currencies will be gathered that the monetary system can be guided ‘scientifically’, that is according to some norm.”

12. Why did it take such a long time for IT to be adopted?Why was Lindahl’s forecast more correct than Fisher’s and Wicksell’s?One answer is found in the literature on policy changes…

16. The literature suggests that IT was adopted in the 1990s because the old monetary regime – in most cases a regime based on pegged exchange rates - was discredited – it had proved to be a failure. And there was a promising alternative to be tried, that is ITSee Figure 1. The policy learning process. A stylized picture.

17. Figure 1. The policy learning process. A stylized picture

18. Policy-makers learn during and after crisesCrises create “a window of opportunity” for rejecting a monetary regime that is perceived as a failure. Crises are the major driving force behind policy changes.The 1930s and the 1990s are prime examples

19. Intellectual cross-country contagionPolicy export (import) of inflation targeting was (and is) another driving force behind the spread of IT

20. The role of the economics profession (of new economic theories)?Economists often enter after the actual event – giving intellectual support for the new monetary regime.

21. Thornton’s explanation of the move to inflation targeting (in the US): 1. Central banks can control inflation (Volcker’s disinflation 1979-87)2. Fiscal policy was “running large and persistent deficits” while the inflation was kept low3. The rejection of a permanent Phillips curve trade-offThe role of crises as driving policy changes is neglected

22. The future of IT(The dangers to IT)Thornton’s threats:1- Dual mandate – flexible IT2. A little inflation is good for economic growth3. Hierarchial mandate

23. The future of IT(The dangers to IT)The history of switches of monetary regimes identifies a clear danger to the supremacy of IT:If the global financial crisis of today is regarded as caused by inflation targeting, then inflation targeting is in great danger. It will be a victim of the crisis – replaced by something new.

24. The future of IT(The dangers to IT)There are signs of rising critique of ITJoseph Stiglitz (May 6th, 2008) Burma Digest: The failure of inflation targeting:One hopes that most countries will have the good sense not to implement inflation targeting; my sympathies go to the unfortunate citizens of those that do. (Among the list of those who have officially adopted inflation targeting in one form or another are: Israel, the Czech Republic, Poland, Brazil, Chile, Colombia, South Africa, Thailand, Korea, Mexico, Hungary, Peru, the Philippines, Slovakia, Indonesia, Romania, New Zealand, Canada, the United Kingdom, Sweden, Australia, Iceland, and Norway.)

25. Implications for IT central banksThornton’s advice: Central banks should be open, honest and realistic about IT

26. Implications for IT central banksMy advice – based on monetary history: 1. Central banks should blame the present crisis on anything but inflation targeting.2. Central banks should argue that inflation targeting is the best regime to minimize the risk of future crises.

27. This is the way to give IT a life in the futureYou have to win the blame-gameOtherwise IT is likely to end up on the scrap-heap of monetary regimes

28. Comments on:Daniel L. Thornton The Evolution to Inflation Targeting: How Did We Get Here and Where Do We Need to Go? Lars Jonung DG ECFIN, EUROPEAN COMMISSION, Brussels 6th Norges Bank Monetary Policy Conference, June 11-12, 2009 The views expressed are my own and should not be attributed to the European Commission

29. A personal note:I am a strong supporter of inflation targeting.In 1978 a proposal that the Riksbank should move to IT based on a corridor between 0 and 2 percent rate of inflation per year. But I made no forecast when … And I see no alternative regime in the future except a modified IT regime encompassing asset prices – although Wicksell did not discuss asset prices.

31. The structure of the paper:1. The evolution of US monetary policy in the past 50 years (since the author took his first course in economics 45 years ago). (13.5 pages)2.The “dramatic shift to inflation targeting (IT)” in spite of “widespread scepticism” in the US economics profession to the ability of central banks to control inflation. (4 pages)3. The success of IT (1 page)4. The dangers to IT (14 pages)5. Implications for inflation-targeting central banks (0.5 page)