What I have in mind is that the Bank of Japan would announce its intention to restore the price level (as measured by some standard index of prices, such as the consumer price index excluding fresh food) to the value it would have reached if, instead of the deflation of the past five years, a moderate inflation of, say, 1 percent per year had occurred.

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Reflation--that is, a period of inflation above the long-run preferred rate in order to restore the earlier price level--proved highly beneficial following the deflations of the 1930s in both Japan and the United States. Finance Minister Korekiyo Takahashi brilliantly rescued Japan from the Great Depression through reflationary policies in the early 1930s, while President Franklin D. Roosevelt's reflationary monetary and banking policies did the same for the United States in 1933 and subsequent years.

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Eggertsson and Woodford (2003) have advanced a second argument for a price-level target for Japan in an important recent paper on monetary policy at the zero bound. These authors point out (as have many others) that, when nominal interest rates are at or near zero, the central bank can lower the real rate of interest only by creating expectations of inflation on the part of the public. Eggertsson and Woodford argue that a publicly announced price-level target of the type just described is more conducive to raising near-term inflation expectations than is an inflation target.

To move substantially further in the direction of inflation targeting, should it choose to do so, the Fed would have to take two principal steps: first, to quantify (numerically, and in terms of a specific price index) what the Federal Open Market Committee means by "price stability", and second, to publish regular medium-term projections or forecasts of the economic outlook, analogous to the Inflation Reports published by both inflation-targeting central banks.

The publication of medium-term forecasts does not raise nearly the same difficult political and communication issues that quantification of price stability may, in my view, and so I propose it here as a more feasible short-term step. The FOMC already releases (and has released since 1979) a range and a "central tendency" of its projections for nominal GDP growth, real GDP growth, PCE inflation, and the civilian unemployment rate twice each year, publishing them as part of the semiannual Monetary Policy Report to the Congress.  These projections are actually quite interesting, as they represent the views of Fed policymakers of the future evolution of the economy, conditional on what each policymaker views as the best path for future policy. Two drawbacks of these projections as they now stand are that (1) they are sometimes not released for a number of weeks (the time between the FOMC meeting at which they are assembled and the Chairman's testimony to the Congress), and (2) the January projections cover only the remainder of the current year (the July projections cover the remainder of the current year and all of the subsequent year).

I think it would be very useful to detach these projections from the Monetary Policy Report and instead release them shortly after the meetings (in January and July) at which they are compiled. I would also suggest adding a second year of forecast to the January projection, to make it more parallel to the July projection as well as to the forecasts in the staff-prepared Greenbook. By releasing the projections in a more timely manner, and by adding a year to the January projection, the FOMC could provide quite useful information to the public. In particular, the FOMC projections would convey the policymakers' sense of the medium-term evolution of the economy, providing insight into both the Fed's diagnosis of economic conditions and its policy objectives.   Ideally, the release of these projections also would provide occasions for Governors and regional Bank Presidents, drawing on the expertise of their respective staffs, to convey their individual views on the prospects for the economy and the objectives of monetary policy.

Is there then no middle ground for policymakers between the inflexibility of ironclad rules and the instability of unfettered discretion? My thesis today is that there is such a middle ground--an approach that I will refer to as constrained discretion--and that it is fast becoming the standard approach to monetary policy around the world, including in the United States. As I will explain, constrained discretion is an approach that allows monetary policymakers considerable leeway in responding to economic shocks, financial disturbances, and other unforeseen developments. Importantly, however, this discretion of policymakers is constrained by a strong commitment to keeping inflation low and stable.

The Federal Reserve’s monetary policy actions under Alan Greenspan have probably also been quite consistent with what would have been done under an inflation-targeting regime. Furthermore, as I have pointed out elsewhere (Mishkin, 2000), the United States has a nominal anchor that has been very effective in recent years—it is Alan Greenspan. Thus it is not at all clear that adoption of inflation targeting in the United States would have improved recent monetary policy performance. However, there is still a strong argument for adoption of inflation targeting by the United States. No matter how good a nominal anchor Alan Greenspan is, he won’t be around forever.

Allowing for the upward biases in inflation measurement and a zone of safety to avoid accidental deflation in prices, an inflation target in the range of 1-2% per annum for the core PCE deflator might be a good initial choice, although some might reasonably disagree about either the number or the choice of index.

For all these conceptual uncertainties and measurement problems, a specific numerical inflation target would represent an unhelpful and false precision. Rather, price stability is best thought of as an environment in which inflation is so low and stable over time that it does not materially enter into the decisions of households and firms.

The central bank is capable of achieving an inflation objective, at least on average over a period of years. In contrast, if we define full employment in terms of a threshold for the unemployment rate consistent with maximum sustainable employment, the central bank has no choice about what this threshold should be. It is determined by the structure of the economy, including the effectiveness of institutions and markets in matching vacancies and unemployed workers, and by policies, such as the levels of unemployment compensation and minimum wage rates.

In our case, stating a numerical target for the inflation rate of some specific price index, for instance, might not enhance transparency but instead diminish it. One could argue that, despite the best efforts of government economists and statisticians, inflation measures based on our various price indexes are not sufficiently refined to offer an accurate basis for defining price stability.

In evaluating risks with respect to our price stability objective, I believe that it is preferable to consider all the various measures and not be unduly influenced by a numerical target for any specific index. Obviously, under these circumstances, changing policy just because a single, specific price index is out of line might not always be sensible, especially if doing so might have detrimental consequences for our other objectives. For this reason, it seems to me that defining our price stability objective in terms of a numerical target for the rate of inflation of some specific price index could well be problematic.

The inflation forecast and the inflation report are key elements in making policy under the inflation target set by the government and in explaining the policy to the public. MPC members agreed that the process of arriving at the forecast has many useful aspects. It has helped the Committee come to some common understandings on a basic framework for analysis of economic developments, the causes of inflation, and the transmission of monetary policy.

Many potential inflation targeters ask, "Why not zero?"...[One] reason for shooting at a rate of inflation slightly above zero is known as the zero bound problem. If a country's real interest rates are close to zero and its inflation rate is close to zero, its nominal interest rates will also be close to zero. Since costs of holding cash are minimal, a central bank cannot push nominal interest rates much below zero. This means that countries that target for zero inflation could get in the bind of being unable to ease monetary policy in response to recessionary shocks.